FORWARD LOOKING STATEMENTS

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of Sovereign Bancorp, Inc. (“Sovereign” or the “Company”). Sovereign may from time to time make forward-looking statements in Sovereign’s filings with the Securities and Exchange Commission (the “SEC” or the “Commission”) (including this Quarterly Report on Form 10-Q and the Exhibits hereto), in its reports to shareholders (including its ~~2006~~2007 Annual Report) and in other communications by Sovereign, which are made in good faith by Sovereign, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Some of the ~~disclosure communications~~statements made by Sovereign, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “will,” “would,” “believe,” “expect,” “hope,” “anticipate,” “estimate,” “intend,” “plan,” “strive,” “hopefully,” “try,” “assume” or similar expressions constitute forward-looking statements.

These forward-looking statements include statements with respect to Sovereign’s vision, mission, strategies, goals, beliefs, plans, objectives, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business of ~~Sovereign, including statements relating to:~~

~~These forward-looking statements, implicitly and explicitly, include the assumptions underlying the statements.~~Sovereign. Although Sovereign believes that the expectations reflected in these forward-looking statements are reasonable, these statements are not guarantees of future performance and involve risks and uncertainties which are subject to change based on various important factors (some of which are beyond Sovereign’s control). ~~The following~~Among the factors ~~among others, could~~which would cause Sovereign’s financial performance to differ materially from ~~its goals, plans, objectives, intentions, expectations, forecasts and projections (and the underlying assumptions)~~that expressed in the forward-looking ~~statements:~~statements are:

	•		the strength of the United States economy in general and the strength of the regional and local economies in which Sovereign conducts operations;

	•		the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;

	•		inflation, interest rate, market and monetary fluctuations;

	•		adverse changes ~~may occur~~ in the securities markets, including those related to the financial condition of significant issuers in our investment portfolio;

	•		revenue enhancement ~~ideas~~initiatives may not be successful in the marketplace or may result in unintended costs;

	•		changing market conditions may force us to alter the implementation or continuation of cost savings or revenue enhancement strategies;

	•		Sovereign’s timely development of competitive new products and services in a changing environment and the acceptance of such products and services by customers;

	•		the willingness of customers to substitute competitors’ products and services and vice versa;

	•		the ability of Sovereign and its third party vendors to convert and maintain Sovereign’s data processing and related systems on a timely and acceptable basis and within projected cost estimates;

	•		the impact of changes in financial services policies, laws and regulations, including laws, regulations ~~policies~~ and ~~practices~~policies concerning taxes, banking, capital, liquidity, proper accounting treatment, securities and insurance, and the application thereof by regulatory bodies and the impact of changes in and interpretation of generally accepted accounting ~~principles;~~principles in the United States;

PART 1- FINANCIAL INFORMATION

Item 1. Financial Information

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)


	September 30,			December 31,			June 30,			December 31,
	2007			2006			2008			2007
	(in thousands, except share data)						(in thousands, except share data)
ASSETS
Cash and amounts due from depository institutions	$	3,992,731		$	1,804,117		$	1,140,965		$	3,130,770
Investment securities:
Available-for-sale		14,307,929			13,874,628			11,118,184			13,941,847
Other investments		981,921			1,003,012			944,606			1,200,545
Loans held for investment		56,579,351			54,976,675			56,936,597			57,232,019
Allowance for loan losses		(629,747	)		(471,030	)		(808,748	)		(709,444	)


Net loans held for investment		55,949,604			54,505,645			56,127,849			56,522,575


Loans held for sale		569,013			7,611,921			469,189			547,760
Premises and equipment		559,040			605,707			559,986			562,332
Accrued interest receivable		384,812			422,901			298,741			350,534
Goodwill		5,003,022			5,005,185			3,430,653			3,426,246
Core deposit intangibles and other intangibles, net of accumulated amortization of $724,794 and $629,218 at September 30, 2007 and December 31, 2006, respectively		402,257			498,420
Core deposit intangibles and other intangibles, net of accumulated amortization of $812,163 and $754,935 at June 30, 2008 and December 31, 2007, respectively								314,888			372,116
Bank owned life insurance		1,773,829			1,725,222			1,820,403			1,794,099
Other assets		2,683,170			2,585,091			2,971,985			2,897,572


TOTAL ASSETS	$	86,607,328		$	89,641,849		$	79,197,449		$	84,746,396


LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits and other customer accounts	$	50,098,048		$	52,384,554		$	47,294,108		$	49,915,905
Borrowings and other debt obligations		26,161,337			26,849,717			22,050,359			26,126,082
Advance payments by borrowers for taxes and insurance		94,373			98,041			101,555			83,091
Other liabilities		1,381,581			1,508,753			1,370,339			1,482,563


TOTAL LIABILITIES		77,735,339			80,841,065			70,816,361			77,607,641


Minority interests		146,075			156,385			147,139			146,430


STOCKHOLDERS’ EQUITY
Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares authorized; 8,000 shares issued and outstanding at September 30, 2007 and December 31, 2006		195,445			195,445
Common stock; no par value; 800,000,000 shares authorized; 481,819,892 shares issued at September 30, 2007 and 479,228,330 shares issued at December 31, 2006		6,277,292			6,183,281
Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares authorized; 8,000 shares outstanding at June 30, 2008 and December 31, 2007								195,445			195,445
Common stock; no par value; 800,000,000 shares authorized; 663,702,053 shares issued at June 30, 2008 and 482,773,610 shares issued at December 31, 2007								7,701,024			6,295,572
Warrants and employee stock options issued		347,630			343,391			348,844			348,365
Unallocated common stock held by the Employee Stock Ownership Plan at cost; 0 shares at September 30, 2007 and 2,760,133 shares at December 31, 2006		—			(19,019	)
Treasury stock at cost; 1,384,143 shares at September 30, 2007 and 2,713,086 shares at December 31, 2006		(20,359	)		(49,028	)
Treasury stock at cost; 1,060,605 shares at June 30, 2008 and 1,369,453 shares at December 31, 2007								(10,531	)		(19,853	)
Accumulated other comprehensive loss		(218,155	)		(24,746	)		(720,036	)		(326,133	)
Retained earnings		2,144,061			2,015,075			719,203			498,929


TOTAL STOCKHOLDERS’ EQUITY		8,725,914			8,644,399			8,233,949			6,992,325


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	86,607,328		$	89,641,849		$	79,197,449		$	84,746,396

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three-Month Period					Nine-Month Period						Three-Month Period				Six-Month Period
	Ended September 30,					Ended September 30,						Ended June 30,				Ended June 30,
	2007			2006		2007			2006			2008		2007		2008		2007
				(in thousands, except per share data)								(in thousands, except per share data)
INTEREST INCOME:
Interest-earning deposits	$	7,117		$	5,408	$	17,497		$	10,478		$	997	$	4,144	$	3,961	$	10,380
Investment securities:
Available-for-sale		177,125			202,831		547,212			409,579			156,164		180,252		324,273		370,087
Held-to-maturity		—			—		—			104,026
Other investments		11,886			13,287		37,366			31,906			6,671		11,179		16,491		25,480
Interest on loans		954,014			1,019,325		2,914,841			2,516,413			837,988		943,860		1,733,264		1,960,827


TOTAL INTEREST INCOME		1,150,142			1,240,851		3,516,916			3,072,402			1,001,820		1,139,435		2,077,989		2,366,774


INTEREST EXPENSE:
Deposits and customer accounts		408,680			412,858		1,231,547			950,725			228,546		409,616		543,649		822,867
Borrowings and other debt obligations		284,701			336,206		887,371			787,161			267,144		276,435		546,030		602,670


TOTAL INTEREST EXPENSE		693,381			749,064		2,118,918			1,737,886			495,690		686,051		1,089,679		1,425,537


NET INTEREST INCOME		456,761			491,787		1,397,998			1,334,516			506,130		453,384		988,310		941,237
Provision for credit losses		162,500			45,000		259,500			118,500			132,000		51,000		267,000		97,000


NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		294,261			446,787		1,138,498			1,216,016			374,130		402,384		721,310		844,237


NON-INTEREST INCOME:
Consumer banking fees		73,113			74,298		218,395			202,563			80,969		77,268		154,160		145,282
Commercial banking fees		44,155			47,690		145,609			130,655			53,747		52,046		108,200		101,454
Mortgage banking (loss)/income		3,752			14,329		(76,953	)		31,845
Capital markets (expense) revenue		(12,627	)		4,009		(956	)		10,211
Mortgage banking income/(loss)													37,897		26,500		32,764		(80,705	)
Capital markets revenue													7,209		5,982		17,602		11,671
Bank owned life insurance		24,439			20,116		65,222			46,802			19,065		20,274		38,489		40,783
Miscellaneous income		8,557			11,409		26,251			26,091			6,322		8,227		11,619		17,694


TOTAL FEES AND OTHER INCOME		141,389			171,851		377,568			448,167			205,209		190,297		362,834		236,179
Net gain/(loss) on investment securities		1,884			29,154		2,854			(275,873	)
Net gain on investment securities													1,908		—		16,043		970


TOTAL NON-INTEREST INCOME		143,273			201,005		380,422			172,294			207,117		190,297		378,877		237,149


GENERAL AND ADMINISTRATIVE EXPENSES:
Compensation and benefits		172,319			182,607		517,672			475,852			192,760		171,557		377,872		345,353
Occupancy and equipment expenses		75,217			78,594		231,373			210,942			74,868		75,637		152,881		156,156
Technology expense		23,940			25,128		71,088			69,808			25,728		23,812		50,226		47,148
Outside services		16,434			17,928		48,681			49,275			15,542		16,969		31,172		32,247
Marketing expense		16,296			14,552		42,220			39,322			19,699		17,092		35,945		25,924
Other administrative expenses		37,440			33,009		97,200			89,891			53,266		31,525		93,031		59,760


TOTAL GENERAL AND ADMINISTRATIVE EXPENSES		341,646			351,818		1,008,234			935,090			381,863		336,592		741,127		666,588

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE ~~NINE-MONTH~~SIX-MONTH PERIOD ENDED ~~SEPTEMBER~~JUNE 30, ~~2007~~

2008
(Unaudited)
(in thousands)


											Unallocated															Common													Accumulated						Total
	Common										Common						Accumulated						Total			Shares							Warrants						Other						Stock-
	Shares							Warrants			Stock						Other						Stock-			Out-			Preferred		Common		& Stock			Treasury			Comprehensive			Retained			Holders’
	Out-			Preferred		Common		& Stock			Held by			Treasury			Comprehensive			Retained			Holders’			Standing			Stock		Stock		Options			Stock			Income/(Loss)			Earnings			Equity
	Standing			Stock		Stock		Options			ESOP			Stock			Income/(Loss)			Earnings			Equity
Balance, December 31, 2006		473,755		$	195,445	$	6,183,281	$	343,391		$	(19,019	)	$	(49,028	)	$	(24,746	)	$	2,015,075		$	8,644,399

Balance, December 31, 2007																											481,404		$	195,445	$	6,295,572	$	348,365		$	(19,853	)	$	(326,133	)	$	498,929		$	6,992,325
Comprehensive income:

Net income		—			—		—		—			—			—			—			253,721			253,721			—			—		—		—			—			—			227,574			227,574
Change in unrealized gain/loss, net of tax:

Investment securities available for sale		—			—		—		—			—			—			(161,095	)		—			(161,095	)		—			—		—		—			—			(399,254	)		—			(399,254	)

Pension liabilities		—			—		—		—			—			—			1,401			—			1,401			—			—		—		—			—			249			—			249

Cash flow hedge derivative financial instruments		—			—		—		—			—			—			(33,715	)		—			(33,715	)


Cash flow hedges																											—			—		—		—			—			5,102			—			5,102

Total comprehensive income																								60,312																						(166,329	)

Stock issued in connection with employee benefit and incentive compensation plans		3,486			—		28,518		(852	)		—			36,212			—			—			63,878			1,188			—		5,113		(1,471	)		12,439			—			—			16,081

Employee stock options earned		—			—		—		5,091			—			—			—			—			5,091			—			—		—		1,950			—			—			—			1,950
Dividends paid on common stock		—			—		—		—			—			—			—			(114,737	)		(114,737	)
Dividends paid on preferred stock		—			—		—		—			—			—			—			(10,950	)		(10,950	)		—			—		—		—			—			—			(7,300	)		(7,300	)
Cumulative transition adjustment related to the adoption of FIN 48		—			—		—		—			—			—			—			952			952

Issuance of common stock		741			—		17,819		—			—			—			—			—			17,819			180,309			—		1,400,339		—			—			—			—			1,400,339
ESOP shares sold in conjunction with plan termination		1,102			—		18,980		—			7,594			—			—			—			26,574
Allocation of ESOP shares		1,658			—		28,694		—			11,425			—			—			—			40,119
Stock repurchased		(306	)		—		—		—			—			(7,543	)		—			—			(7,543	)		(260	)		—		—		—			(3,117	)		—			—			(3,117	)


Balance, September 30, 2007		480,436		$	195,445	$	6,277,292	$	347,630		$	—		$	(20,359	)	$	(218,155	)	$	2,144,061		$	8,725,914
Balance, June 30, 2008																											662,641		$	195,445	$	7,701,024	$	348,844		$	(10,531	)	$	(720,036	)	$	719,203		$	8,233,949

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	Nine-Month Period						Six-Month Period
	Ended September 30,						Ended June 30,
	2007			2006			2008			2007
	(in thousands)						(in thousands)
CASH FLOWS FROM OPERATING ACTIVITES:		��
Net income	$	253,721		$	266,351		$	227,574		$	195,511
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses		259,500			118,500			267,000			97,000
Depreciation and amortization		201,218			155,427			119,531			133,782
Net amortization/accretion of investment securities and loan premiums and discounts		37,044			90,022			18,286			25,712
Net (gain)/loss on sale of loans		47,792			(34,453	)		(26,766	)		47,497
Net (gain)/loss on investment securities		(2,854	)		275,873
Net gain on investment securities								(16,043	)		(970	)
Net loss on real estate owned and premises and equipment		4,274			896			6,165			393
Loss on debt extinguishments		14,714			—			—			13,782
Net loss on economic hedges		—			11,387
Stock-based compensation		21,140			22,442			12,330			14,043
Allocation of Employee Stock Ownership Plan		40,119			—			—			40,119
Origination and purchases of loans held for sale, net of repayments		(3,555,147	)		(2,157,720	)		(3,793,753	)		(2,201,980	)
Proceeds from sales of loans held for sale		3,383,813			1,819,931			3,933,343			2,021,862
Net change in:
Accrued interest receivable		38,089			(47,882	)		51,793			54,052
Other assets and bank owned life insurance		(129,471	)		(1,955,915	)		72,023			46,972
Other liabilities		(128,197	)		69,645			(121,408	)		(106,619	)

Net cash provided by/(used in) operating activities		485,755			(1,365,496	)
Net cash provided by operating activities								750,075			381,156


CASH FLOWS FROM INVESTING ACTIVITIES:
Adjustments to reconcile net cash used in investing activities:
Proceeds from sales of investment securities:
Available-for-sale		127,718			9,644,535			110,657			124,506
Held-to-maturity		—			1,774,475
Proceeds from repayments and maturities of investment securities:
Available-for-sale		3,992,785			1,496,817			3,164,698			3,721,591
Held-to-maturity		—			186,845
Net change in other short-term investments		(1,829,529	)		(331,916	)
Net change in other investments								255,939			353,490
Purchases of available-for-sale investment securities		(2,943,917	)		(10,481,973	)		(266,860	)		(3,635,412	)
Purchases of held-to-maturity investment securities		—			(557,704	)
Proceeds from sales of loans		9,080,571			4,003,156
Proceeds from sales of loans held for investment								118,117			8,971,331
Purchase of loans		(176,063	)		(6,546,275	)		(210,287	)		(96,306	)
Net change in loans other than purchases and sales		(3,462,251	)		(3,394,957	)		(593,436	)		(2,765,442	)
Proceeds from sales of premises and equipment		26,046			13,408			3,565			19,365
Purchases of premises and equipment		(43,804	)		(76,074	)		(42,355	)		(27,761	)
Proceeds from sales of real estate owned		12,441			5,249			18,763			7,166
Net cash (paid)/received from business combinations		—			(2,713,208	)

Net cash (provided by)/used in investing activities		4,783,997			(6,977,622	)
Net cash provided by investing activities								2,558,801			6,672,528

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, ~~except~~expect per share amounts)

(Unaudited)

(1) BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

The accompanying financial statements of Sovereign Bancorp, Inc. and Subsidiaries (“Sovereign” or the “Company”) include the accounts of the parent company, Sovereign Bancorp, Inc. and its subsidiaries, including the following wholly-owned subsidiaries: Sovereign Bank (the “Bank”), Independence Community Bank Corp. (“Independence”), and Sovereign Delaware Investment Corporation. All intercompany balances and transactions have been eliminated in consolidation.

These financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in conformity with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, the accompanying consolidated financial statements reflect all adjustments of a normal and recurring nature necessary to present fairly the consolidated balance sheet, statements of operations, stockholders’ equity and cash flows for the periods indicated, and contain adequate disclosure to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the Company’s latest annual report on Form 10-K.

The preparation of these financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for any interim periods are not necessarily indicative of the results which may be expected for the entire year.

(2) EARNINGS PER SHARE

Basic earnings per share is calculated by dividing net income by the weighted average common shares outstanding, excluding options and warrants. The dilutive effect of our options is calculated using the treasury stock method and the dilutive effect of our warrants that were issued in connection with our contingently convertible debt issuance is calculated under the if-converted method.

The following table presents the computation of earnings per share for the periods indicated (amounts in thousands, except per share):


	Three-Month Period						Nine-Month Period						Three-Month Period						Six-Month Period
	Ended September 30,						Ended September 30,						Ended June 30,						Ended June 30,
	2007			2006			2007			2006			2008			2007			2008			2007
CALCULATION OF INCOME FOR BASIC AND DILUTED EPS:
Net income as reported and for basic EPS	$	58,210		$	184,009		$	253,721		$	266,351		$	127,439		$	147,452		$	227,574		$	195,511
Less preferred dividend		(3,650	)		(1,825	)		(10,950	)		(4,258	)		(3,650	)		(3,650	)		(7,300	)		(7,300	)

Net income available to common stockholders		54,560			182,184			242,771			262,093			123,789			143,802			220,274			188,211
Contingently convertible trust preferred interest expense, net of tax (1)		—			6,344			—			19,006			—			6,413			—			12,825

Net income for diluted EPS available to common stockholders	$	54,560		$	188,528		$	242,771		$	281,099		$	123,789		$	150,215		$	220,274		$	201,036


WEIGHTED AVERAGE SHARES OUTSTANDING:
Weighted average basic shares(3)		480,171			472,447			477,884			420,673			570,056			478,278			527,164			476,722
Dilutive effect of:
Warrants (1)		—			27,435			—			27,427			—			27,435			—			27,435
Stock options ~~(1)~~(2)		—			6,253			—			6,165			1,302			6,928			1,654			6,923

Weighted average diluted shares(3)		480,171			506,135			477,884			454,265			571,358			512,641			528,818			511,080


EARNINGS PER SHARE:
Basic	$	0.11		$	0.39		$	0.51		$	0.62		$	0.22		$	0.30		$	0.42		$	0.39
Diluted	$	0.11		$	0.37		$	0.51		$	0.62		$	0.22		$	0.29		$	0.42		$	0.39

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, expect per share amounts)
(Unaudited)

(3) INVESTMENT SECURITIES (continued)

The ~~unrealized losses on corporate debt and asset backed securities include $93.5 million~~following table discloses the aggregate amount of unrealized losses as of June 30, 2008 and December 31, 2007 on ~~$750 million of highly rated investments~~securities in ~~collateralized debt obligations (“CDOs”) at September 30, 2007. These CDOs consist of interests in structured investment vehicles backed by investment grade corporate loans. In all of the CDOs,~~ Sovereign’s investment ~~is senior~~portfolio classified according to the amount of time that those securities have been in a ~~subordinated tranche(s) which have first~~continuous loss ~~exposure. We~~position (in thousands):


	At June 30, 2008
	Less than 12 months					12 months or longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
U.S. Treasury and government agency securities	$	59,206	$	(266	)	$	—	$	—		$	59,206	$	(266	)
Corporate debt and asset-backed securities		4,794		(64	)		399,492		(411,855	)		404,286		(411,919	)
Equity securities		597,484		(34,468	)		253		(1	)		597,737		(34,469	)
State and municipal securities		489,064		(13,597	)		1,382,644		(83,275	)		1,871,708		(96,872	)
Mortgage-backed Securities:
U.S. government agencies		—		—			1,130		(34	)		1,130		(34	)
FHLMC and FNMA debt securities		1,144,757		(23,804	)		25,221		(782	)		1,169,978		(24,586	)
Non-agency securities		896,266		(77,107	)		1,852,184		(240,401	)		2,748,450		(317,508	)


Total investment securities available-for-sale	$	3,191,571	$	(149,306	)	$	3,660,924	$	(736,348	)	$	6,852,495	$	(885,654	)


	At December 31, 2007
	Less than 12 months					12 months or longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
Debentures of FHLB, FNMA and FHLMC	$	—	$	—		$	1,009	$	(1	)	$	1,009	$	(1	)
Corporate debt and asset-backed securities		223,813		(81,066	)		398,924		(113,173	)		622,737		(194,239	)
Equity securities		253		(1	)		—		—			253		(1	)
State and municipal securities		1,510,114		(25,880	)		18,697		(523	)		1,528,811		(26,403	)
Mortgage-backed Securities:
U.S. government agencies		26		—			1,392		(56	)		1,418		(56	)
FHLMC and FNMA debt securities		11,020		(46	)		91,600		(1,551	)		102,620		(1,597	)
Non-agency securities		1,511,132		(41,875	)		1,475,522		(56,279	)		2,986,654		(98,154	)


Total investment securities available-for-sale	$	3,256,358	$	(148,868	)	$	1,987,144	$	(171,583	)	$	5,243,502	$	(320,451	)

As of June 30, 2008, management has concluded ~~these~~that the unrealized losses above on its investment securities (which totaled 282 individual securities) are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for athe time necessary to recover its cost ~~and will ultimately recover its cost~~which for debt securities may be at maturity (i.e. these investments have contractual maturities that, absent credit default, ensure Sovereign will ultimately recover its cost). In making its other-than-temporary impairment evaluation, Sovereign considered the fact that the principal and interest on these securities are from U.S. Government and Government Agencies as well as issuers that are investment grade. The change in the unrealized losses on the U.S. Government and Government Agencies mortgage-backed securities, Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”) securities and the non-agency mortgage-backed securities were caused by changes in credit spreads and liquidity issues in the marketplace.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, expect per share amounts)
(Unaudited)

(3) INVESTMENT SECURITIES (continued)

At June 30, 2008, Sovereign had 8 securities totaling $622.6 million of perpetual preferred stock of FHLMC and FNMA which had an unrealized loss of $34.4 million. These losses are related to liquidity spreads due to negative events on the issuers of these securities. These securities have experienced significant changes in prices month-to-month based on movements in credit spreads and as recently as May 31, 2008, the securities were in a net unrealized gain position of $11.3 million. We perform an analysis of the individual securities each quarter and evaluate the prospects of the issuers when considering whether an other-than-temporary impairment exists. As of June 30, 2008, each of the individual securities was investment grade. Given the short duration of the losses and the fact that the losses were not severe, we concluded that the above unrealized losses are temporary in nature at June 30, 2008.

Recent news stories in July and concerns in the marketplace have resulted in significant decreases in the share prices of Fannie Mae and Freddie Mac. Since June 30, 2008, the common stock prices for Fannie Mae and Freddie Mac have been very volatile and have declined significantly. It is widely believed that the U.S. government will support these two government sponsored entities if needed and has publicly stated so, but it is unclear whether the support would extend to their common and preferred shareholders. Their primary regulator has also stated that both institutions are adequately capitalized. In July, a housing and economic recovery bill was signed into law by the President of the United States which allows the U.S. Treasury Department the authority to purchase equity in both Fannie Mae and Freddie Mac. The housing and recovery bill also permits the Treasury Department to provide a temporary increase in a long standing line of credit for the two companies. The Fed’s Board also granted the New York Fed authority to lend to Fannie Mae and Freddie Mac should such lending prove necessary. Finally, the housing and recovery bill also includes an increase in the federal debt limit to $10.6 trillion and a $300 billion program to refinance loans for struggling borrowers in an effort to help stabilize the U.S. housing market.

The concerns around capital adequacy and the likely dilution on existing shareholders when capital is raised for these two companies has caused the market valuations of the Company’s Fannie Mae and Freddie Mac perpetual preferred stock to decrease significantly in July. It is unclear whether the values of Sovereign’s investment in Fannie Mae and Freddie Mac perpetual preferred stock will change once additional facts and circumstances become known which may not be until Fannie Mae and Freddie Mac release second quarter earnings and the U.S. Government determines the final form of any changes to support Fannie Mae and Freddie Mac. To the extent the market conditions do not improve and the values for these securities do not stabilize, it is possible that Sovereign could have an additional other than temporary impairment charge in future periods.

The unrealized losses on corporate debt and asset backed securities include $390.5 million of unrealized losses on $750 million of highly rated investments in collateralized debt obligations (“CDOs”) at June 30, 2008. These CDOs consist of interests in credit default swaps on investment grade corporate credits. These credits are primarily to companies based in North America and Europe. Additionally, the credits are to various industries with no specific industries exceeding 8.5% of the total investment pool. In all of the CDOs, Sovereign’s investment is senior to one or more subordinated tranche(s) which have first loss exposure. The Company believes that these losses are primarily related to market interest rates and credit spreads and not underlying credit issues associated with the issuers of the debt obligations. The CDOs were purchased in the second and third quarters of 2006 and have not experienced any losses to date. Sovereign does not believe it should have any loss of principal on these investments given its senior position and the protection that the subordinated classes provide.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars in thousands, except per share amounts)~~
~~(Unaudited)~~

~~(3) INVESTMENT SECURITIES (continued)~~

~~During the three month period ended June 30, 2006, following the acquisition~~ The weighted average contractual life of Independence (discussed in Note 16), Sovereign sold $3.5 billion of investment securities with a combined effective yield of 4.40% for asset/liability management purposes, to maintain compliance with its existing interest rate policies and guidelines and to offset, in part, the negative effect of the current yield curve on net interest margin for future periods and incurred a pre-tax loss of $238.3 million ($154.9 million after-tax or $0.36 per share). Of the total $3.5 billion of investments sold, $1.8 billion had been previously classified as held-to-maturity and Sovereign recorded a pre-tax loss of $130.1 million related to the sale of the held-to-maturity securities. As a result of the sale of the held-to-maturity securities, Sovereign concluded that it was required to reclassify the remaining $3.2 billion of held-to-maturity investment securities as investments available-for-sale.

this portfolio is 8.4 years. The ~~following table discloses the age of gross unrealized losses in Sovereign’s investment portfolio as of September 30, 2007 and December 31, 2006 (in thousands):~~

At September 30, 2007
Less than 12 months 12 months or longer Total
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
Investment Securities

U.S. Treasury and government agency securities $ — $ — $ 3,027 $ (13 ) $ 3,027 $ (13 )
Debentures of FHLB, FNMA and FHLMC — — 57,822 (60 ) 57,822 (60 )
Corporate debt and asset-backed securities 532,111 (72,819 ) 187,746 (24,592 ) 719,857 (97,411 )
Equity securities 375,770 (11,413 ) — — 375,770 (11,413 )
State and municipal securities 1,759,035 (30,717 ) 21,114 (80 ) 1,780,149 (30,797 )
Mortgage-backed Securities:
U.S. government agencies 215,587 (1,007 ) 2,170 (79 ) 217,757 (1,086 )
FHLMC and FNMA debt securities 3,018,839 (13,686 ) 107,527 (3,000 ) 3,126,366 (16,686 )
Non-agency securities 1,231,445 (18,730 ) 1,643,056 (54,228 ) 2,874,501 (72,958 )

Total investment securities available-for-sale $ 7,132,787 $ (148,372 ) $ 2,022,462 $ (82,052 ) $ 9,155,249 $ (230,424 )

At December 31, 2006
Less than 12 months 12 months or longer Total
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
Investment Securities

U.S. Treasury and government agency securities $ 1,495,712 $ (733 ) $ 15,995 $ (145 ) $ 1,511,707 $ (878 )
Debentures of FHLB, FNMA and FHLMC — — 101,341 (1,149 ) 101,341 (1,149 )
Corporate debt and asset-backed securities 446,261 (4,014 ) 61,820 (2,301 ) 508,081 (6,315 )
State and municipal securities 247,409 (1,312 ) 21,239 (182 ) 268,648 (1,494 )
Mortgage-backed Securities:
U.S. government agencies 219 (8 ) 2,258 (97 ) 2,477 (105 )
FHLMC and FNMA debt securities 641,851 (1,009 ) 126,193 (4,176 ) 768,044 (5,185 )
Non-agency securities 456,897 (1,703 ) 1,962,694 (50,662 ) 2,419,591 (52,365 )

Total investment securities available-for-sale $ 3,288,349 $ (8,779 ) $ 2,291,540 $ (58,712 ) $ 5,579,889 $ (67,491 )

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars in thousands, except per share amounts)~~
~~(Unaudited)~~

~~(3) INVESTMENT SECURITIES (continued)~~

~~As of September 30, 2007, management~~Company has concluded ~~that the~~these unrealized losses ~~above on its investment securities (which totaled 374 individual securities)~~ are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for ~~the~~a time necessary to recover its cost and will ultimately recover its cost at maturity (i.e. these investments have contractual maturities that, absent credit default, ensure Sovereign will ultimately recover its cost). In making its other than temporary impairment evaluation, Sovereign considered the fact that the principal and interest on these securities are from U.S. Government and Government Agencies as well as issuers that are investment grade (Aaa rated).

The ~~change in the~~ unrealized losses on the ~~U.S. Government~~Company’s state and ~~Government Agencies mortgage-backed securities, Federal Home Loan Mortgage Corporation (“FHLMC”)~~municipal bond portfolio increased to $96.9 million at June 30, 2008. This portfolio consists of 100% general obligation bonds of states, cities, counties and ~~Federal National Mortgage Association (“FNMA”) securities~~school districts. The portfolio has a weighted average underlying credit risk rating of AA-. These bonds are insured with various companies and as such, carry additional credit protection. The unrealized losses on the portfolio are due to an increase in credit spreads and liquidity issues in the marketplace and concerns with respect to the financial strength of third party insurers. However, even if it was assumed that the insurers could not honor their obligation, our underlying portfolio is still investment grade and the ~~non-agency mortgage-backed securities were caused by changes~~Company believes that we will collect all scheduled principal and interest. The Company has concluded these unrealized losses are temporary in ~~interest rates. Because~~nature since they are not related to the ~~decline in market value is attributable to changes in interest rates and not~~underlying credit quality of the issuers, and ~~because~~ the Company has the intent and ability to hold ~~those~~these investments ~~until~~for a ~~recovery of fair value, which may be maturity, the Company does not consider those investments~~time necessary to ~~be other-than-temporarily impaired.~~recover its cost.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, expect per share amounts)
(Unaudited)

(3) INVESTMENT SECURITIES (continued)

~~During the second quarter of 2006, Sovereign recorded other-than-temporary impairment charges of $67.5 million on FNMA and FHLMC preferred stock. Sovereign determined that certain~~The unrealized losses on ~~perpetual preferred stock~~the non-agency securities portfolio increased to $317.5 million at June 30, 2008. This portfolio consists primarily of ~~FNMA~~AAA rated non-agency mortgage-backed securities from a diverse group of issuers in the private-label market. The unrealized losses on the portfolio are due to an increase in credit spreads and ~~FHLMC was other-than-temporary~~liquidity issues in ~~accordance with SFAS 115 “Accounting for Certain Investments~~the marketplace. The Company has concluded these unrealized losses are temporary in ~~Debt and Equity Securities” and~~nature since they are not related to the SEC’s Staff Accounting Bulletin No. 59 “Accounting for Non-current Marketable Equity Securities”. The Company’s assessment considered the duration and the severity of the unrealized loss, the financial condition and near-term prospectsunderlying credit quality of the issuers, and the ~~likelihood of~~Company has the ~~market value of~~intent and ability to hold these ~~instruments increasing~~investments for a time necessary to ~~our initial~~recover its cost ~~basis within a reasonable period of time based upon the anticipated interest rate environment. As a result of~~and will ultimately recover its cost at maturity (i.e. these ~~factors,~~investments have contractual maturities that, absent credit default, ensure Sovereign ~~concluded that the unrealized losses were other-than-temporary and recorded a non-cash impairment charge.~~will ultimately recover its cost).

(4) LOANS ~~HELD FOR INVESTMENT~~

The following table presents the composition of the loans held for investment portfolio by type of loan and by fixed and adjustable rates at the dates indicated (dollars in thousands):


	September 30, 2007					December 31, 2006					June 30, 2008					December 31, 2007
	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent
Commercial real estate loans(1)	$	11,650,822		20.6	%	$	11,514,983		21.0	%	$	13,271,241		23.3	%	$	12,306,914		21.5	%
Commercial and industrial loans		13,807,542		24.4			11,561,183		21.0			12,700,012		22.3			12,594,652		22.0
Multifamily loans		3,965,131		7.0			5,621,429		10.2
Multi-family loans												4,559,809		8.0			4,088,992		7.1
Other		245,357		0.4			1,518,603		2.8			1,748,246		3.1			1,765,036		3.1


Total commercial loans held for investment		29,668,852		52.4			30,216,198		55.0			32,279,308		56.7			30,755,594		53.7


Residential mortgages		13,684,909		24.2			14,316,168		26.0			11,543,270		20.3			12,950,811		22.7
Home equity loans and lines of credit		6,058,143		10.7			5,176,346		9.4			6,504,738		11.4			6,197,148		10.8


Total consumer loans secured by real estate		19,743,052		34.9			19,492,514		35.4			18,048,008		31.7			19,147,959		33.5

Auto loans		6,853,381		12.1			4,848,204		8.8			6,306,484		11.1			7,028,894		12.3
Other		314,066		0.6			419,759		0.8			302,797		0.5			299,572		0.5


Total consumer loans held for investment		26,910,499		47.6			24,760,477		45.0			24,657,289		43.3			26,476,425		46.3


Total loans held for investment (1)	$	56,579,351		100.0	%	$	54,976,675		100.0	%
Total loans held for investment (2)											$	56,936,597		100.0	%	$	57,232,019		100.0	%


Total loans held for investment with:
Fixed rate	$	33,119,311		58.5	%	$	32,321,464		58.8	%	$	31,302,053		55.0	%	$	32,903,007		57.5	%
Variable rate		23,460,040		41.5			22,655,211		41.2			25,634,544		45.0			24,329,012		42.5


Total loans held for investment (1)	$	56,579,351		100.0	%	$	54,976,675		100.0	%
Total loans held for investment (2)											$	56,936,597		100.0	%	$	57,232,019		100.0	%

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars in thousands, except per share amounts)~~
~~(Unaudited)~~

~~(4) LOANS (continued)~~

The following table presents the composition of the loan held for sale portfolio by type of ~~loan and by~~loan. Our entire loans held for sale portfolio have fixed ~~and adjustable~~ rates ~~at the dates indicated~~ (dollars in thousands):

September 30, 2007 December 31, 2006
Amount Percent Amount Percent
Commercial real estate $ 170,829 30.0 % $ — — %
Commercial and industrial loans — — 109,123 1.4
Multifamily 73,202 12.9 147,022 1.9
Residential mortgages 324,982 57.1 3,088,562 40.6
Home equity loans and lines of credit — — 4,267,214 56.1

Total loans held for sale $ 569,013 100.0 % $ 7,611,921 100.0 %

Total loans held for sale with:
Fixed rate $ 569,013 100.0 % $ 7,395,494 97.2 %
Variable rate — — 216,427 2.8

Total loans held for sale $ 569,013 100.0 % $ 7,611,921 100.0 %

During the three-month period ended March 31, 2007, Sovereign transferred back into its loan portfolio $658 million of correspondent home equity loans that had been previously classified as held for sale. Due to adverse market conditions for non-prime loans, the Company decided not to sell these loans and to hold them for investment. Before transferring these loans back into the held for investment loan portfolio, Sovereign marked this portfolio to market as of March 31, 2007 utilizing a discounted cash flow model. The discounted cash flow model takes into account expected prepayment factors and the degree of credit risk associated with the loans and the estimated effects of changes in market interest rates relative to the loans’ interest rates. As a result, Sovereign wrote down this loan portfolio by $84.2 million via a reduction to mortgage banking revenues during the three-month period ended March 31, 2007.

During the three-month period ended September 30, 2007, Sovereign recorded lower of cost or market write downs of $5.4 million and $6.2 million on its commercial real estate/multifamily loan portfolios and its commercial and industrial loan syndication portfolios due to widening credit spreads in the market place. These charges were recorded in mortgage banking revenues and commercial banking fees, respectively. Due to adverse market conditions, Sovereign transferred its commercial and industrial loan portfolio of $158 million to loans held for investment. Before transferring these loans into the held for investment portfolio, Sovereign marked down these loans to market using quotations from an external third party pricing service. The commercial real estate/ multi-family portfolios continue to be classified as held for sale at September 30, 2007.

~~(5) DEPOSIT PORTFOLIO COMPOSITION~~

~~The following table presents the composition of deposits and other customer accounts at the dates indicated (dollars in thousands):~~

September 30, 2007 December 31, 2006
Weighted Weighted
Average Average
Account Type Amount Percent Rate Amount Percent Rate
Demand deposit accounts $ 6,272,412 13 % — % $ 6,577,585 12 % — %
NOW accounts 5,352,228 11 1.11 6,333,667 12 1.24
Wholesale NOW 4,319,805 9 4.97 3,573,861 7 4.97
Customer repurchase agreements 2,726,686 5 3.95 2,206,445 4 4.74
Savings accounts 3,984,551 8 0.68 4,637,346 9 0.65
Money market accounts 10,258,960 20 3.71 8,875,353 17 3.17
Wholesale money market accounts 1,556,973 3 5.00 4,116,417 8 5.51
Certificates of deposit 11,970,145 24 4.63 11,338,935 22 4.45
Wholesale certificates of deposit 3,656,288 7 5.19 4,724,945 9 5.14

Total deposits $ 50,098,048 100 % 3.21 % $ 52,384,554 100 % 3.14 %


	June 30, 2008					December 31, 2007
	Amount		Percent			Amount		Percent
Commercial and industrial loans	$	46,817		10.0	%	$	—		—	%
Multi-family loans		109,208		23.3			157,378		28.7
Residential mortgages		313,164		66.7			390,382		71.3


Total loans held for sale	$	469,189		100.0	%	$	547,760		100.0	%

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars in thousands, except per share amounts)~~
~~(Unaudited)~~

~~(7)~~(6) DERIVATIVES

One of Sovereign’s primary market risks is interest rate risk. Management uses derivative instruments to mitigate the impact of interest rate movements on the value of certain liabilities, assets and on probable forecasted cash flows. These instruments primarily include interest rate swaps that have underlying interest rates based on key benchmark indices and forward sale or purchase commitments. The nature and volume of the derivative instruments used to manage interest rate risk depend on the level and type of assets and liabilities on the balance sheet and the risk management strategies for the current and anticipated interest rate environment.

Fair Value Hedges. Sovereign has entered into pay-variable, receive-fixed interest rate swaps to hedge changes in fair values of certain brokered certificates of deposits and certain debt obligations. For the ~~nine-month~~six-month period ended ~~September~~June 30, 2008 and 2007, ~~and 2006, hedge ineffectiveness income/(loss)~~charges of ~~$(1.2)~~$3.2 million and ~~$2.3~~$1.7 million, respectively, ~~was~~were recorded in earnings associated with ~~fair value hedges.~~

During the fourth quarter of 2005, Sovereign terminated $211.3 million of receive fixed-pay variable interest rate swaps that were hedging the fair value of $211.3 million of junior subordinated debentures due to capital trust entities. The fair value adjustment to the basis of the debt was $11.6 million at the date of termination. Sovereign had utilized the short-cut method of assessing hedge effectiveness under SFAS No. 133 when this hedge was in place. On July 21, 2006, in connection with the SEC’s review of the Company’s filings, it was determined that this hedge did not qualify for the short-cut method due to the fact that the junior subordinated debentures contained an interest deferral feature. As a result, Sovereign recorded a pretax charge of $11.4 million in the second quarter of 2006 to write-off the remaining fair value adjustment. This charge was recorded within other expenses on Sovereign’s consolidated statement of operations as losses from economic hedges.ineffectiveness.

Cash Flow Hedges. Sovereign hedges exposures to changes in cash flows associated with forecasted interest payments on variable-rate liabilities, through the use of pay-fixed, receive variable interest rate swaps. The last of the hedges is scheduled to expire in January 2016. For the ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 and ~~2006,~~2007, no hedge ineffectiveness was required to be recognized in earnings associated with cash flow hedges. During the first quarter of 2007, Sovereign terminated $3.2 billion of pay-fixed interest rate swaps that were hedging the future cash flows on $3.2 billion of borrowings, resulting in a net after-tax gain of $1.6 million. The gain will continue to be deferred in accumulated other comprehensive income (AOCI) and will be reclassified into interest expense as the future cash flows occur, unless it becomes probable that the forecasted interest payments originally hedged will not occur, in which case the gain in AOCI will be recognized immediately. No gains or losses deferred in accumulated other comprehensive income were reclassified into earnings during the ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 or ~~2006~~2007 as a result of discontinuance of cash flow hedges for which the forecasted transaction was not probable of occurring. As of ~~September~~June 30, ~~2007,~~2008, Sovereign expects approximately ~~$8.8~~$124.1 million of the deferred net after-tax loss on derivative instruments included in accumulated other comprehensive income to be reclassified to earnings during the next twelve months.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, ~~except~~expect per share amounts)
(Unaudited)

~~(7)~~(6) DERIVATIVES (continued)

The following financial statement line items were impacted by Sovereign’s derivative activity as of and for the ~~nine~~six months ended ~~September~~June 30, ~~2007:~~2008:


	Balance Sheet Effect at	Income Statement Effect For The ~~Nine~~Six Months Ended
Derivative Activity	~~September~~June 30, ~~2007~~2008	~~September~~June 30, ~~2007~~2008
Fair value hedges:
Receive fixed-pay variable interest rate swaps	Decrease to CDs of ~~$10.5~~$0.2 million and ~~an increase~~increases to other assets and other liabilities of ~~$10.5 million.~~$0.7 million and $0.5 million, respectively.	~~Decrease~~Increase in net interest income of ~~$9.5~~$6.7 million.

Cash flow hedges:
Pay fixed-receive floating interest rate swaps	Increase to other ~~assets~~liabilities and ~~other liabilities~~deferred taxes of ~~$1.4~~$213.5 million and ~~$93.8~~$74.7 million, respectively, and a decrease to ~~deferred taxes and~~ stockholders’ equity of ~~$32.3 million and $60.0 million, respectively.~~$138.8 million.	~~Increase~~Decrease in net interest income of ~~$15.5~~$60.3 million.

Other hedges:
Forward commitments to sell loans	Increase to other assets of ~~$3.8~~$2.3 million.	Increase in mortgage banking revenues of ~~$24.9~~$7.1 million.

Interest rate lock commitments	~~Decrease~~Increase to mortgage loans of ~~$2.4~~$1.1 million.	Decrease in mortgage banking revenues of ~~$1.3~~$1.0 million.

Net customer related hedges	Increase to other assets of ~~$20.0~~$38.9 million.	~~Decrease~~Increase in capital markets revenue of ~~$9.6~~$4.1 million.

Forward commitments to sell precious metals inventory, net	Increase to other liabilities of ~~$1.5 million.~~$63 thousand.	~~Decrease~~Increase in commercial banking fees of ~~$1.8~~$1.0 million.

Foreign exchange	Increase to other assets of ~~$0.9~~$5.3 million.	Increase in commercial banking ~~revenues~~fees of ~~$0.6~~$3.4 million.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars in thousands, except per share amounts)~~
~~(Unaudited)~~

~~(7) DERIVATIVES (continued)~~

The following financial statement line items were impacted by Sovereign’s derivative activity as of December 31, ~~2006~~2007 and for the ~~nine~~six months ended ~~September~~June 30, ~~2006:~~2007:


	Balance Sheet Effect at	Income Statement Effect For The ~~Nine~~Six Months
Derivative Activity	December 31, ~~2006~~2007	Ended ~~September~~June 30, ~~2006~~2007
Fair value hedges:
Receive fixed-pay variable interest rate swaps	Decrease to CDs of ~~$22.8~~$1.8 million and ~~an increase~~increases to other assets and other liabilities of ~~$22.8 million.~~$0.4 million and $2.2 million, respectively.	Decrease in net interest income of ~~$14.4~~$6.9 million.

Cash flow hedges:
Pay fixed-receive floating interest rate swaps	Increase to other ~~assets~~liabilities and ~~other liabilities~~deferred taxes of ~~$19.2~~$214.5 million and ~~$45.8~~$75.1 million, respectively, and a decrease to ~~deferred taxes and~~ stockholders’ equity of ~~$9.3 million and $17.3 million, respectively.~~$139.5 million.	Increase in net interest income of ~~$6.7~~$8.5 million.

Other hedges:
Forward commitments to sell loans	Increase to other ~~assets~~liabilities of ~~$0.3~~$4.7 million.	~~Decrease~~Increase in mortgage banking revenues of ~~$0.7~~$31.2 million.

Interest rate lock commitments	~~Decrease~~Increase to mortgage loans of ~~$11 thousand.~~$2.1 million.	~~Increase~~Decrease in mortgage banking revenues of $0.2 million.

Net customer related hedges	Increase to other assets of ~~$30.3~~$34.8 million.	Increase in capital markets revenue of ~~$3.3~~$5.4 million.

Forward commitments and forward settlement arrangements on precious metals	Increase to other ~~assets~~liabilities of ~~$0.3~~$1.0 million.	Increase in commercial banking fees of ~~$1.9~~$1.5 million.

Foreign exchange	Increase to other ~~liabilities~~assets of ~~$90 thousand.~~$1.9 million.	Decrease in commercial banking ~~revenues~~fees of ~~$0.7~~$0.2 million.

Net interest income resulting from interest rate exchange agreements included $118.0 million and $317.2 million of income and $117.1 million and $323.4 million of expense for the three-month and nine-month periods ended September 30, 2007, respectively, compared with $107.6 million and $225.5 million of income and $107.3 million and $233.3 million of expense for the corresponding periods in the prior year.

Net gains generated from derivative instruments (including trading revenues) executed with customers are included as capital markets revenue on the income statement and totaled $2.7 million and $9.2 million for the three months and nine months ended September 30, 2007, respectively, compared with $4.2 million and $9.0 million for the three months and nine months ended September 30, 2006.

1917

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars in thousands, except per share amounts)~~
~~(Unaudited)~~

~~(9) MORTGAGE SERVICING RIGHTS (continued)~~


Gross balance as of December 31, 2007	$	141,076
Mortgage servicing assets recognized		36,531
Amortization		(15,556	)

Gross balance at June 30, 2008		162,051
Valuation allowance		(339	)

Balance as June 30, 2008	$	161,712

The fair value of ~~our~~Sovereign’s residential mortgage servicing rights is estimated using a discounted cash flow model. This model estimates the present value of the future net cash flows of the servicing portfolio based on various assumptions. The most important assumptions in the valuation of residential mortgage servicing rights are anticipated loan prepayment rates (CPR speed) and the positive spread ~~we receive~~Sovereign receives on holding escrow related balances. Increases in prepayment speeds result in lower valuations of mortgage servicing rights. The escrow related credit spread is the estimated reinvestment yield earned on the serviced loan escrow deposits. Increases in escrow related credit spreads result in higher valuations of mortgage servicing rights. For each of these items, Sovereign must make assumptions based on current market information and future expectations. All of the assumptions are based on standards that ~~we believe~~the Company believes would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources. Additionally, an independent appraisal of the fair value of ~~our~~the Company’s residential mortgage servicing rights is obtained annually and is used by management to evaluate the reasonableness of the assumptions used in the Company’s discounted cash flow model.

Listed below are the most significant assumptions that were utilized by Sovereign in its evaluation of residential mortgage servicing rights for the periods presented.


	September 30, 2007			December 31, 2006			September 30, 2006			June 30, 2008			March 31, 2008			December 31, 2007			June 30, 2007			March 31, 2007
CPR speed		12.77	%		14.23	%		12.50	%		12.19	%		20.64	%		14.70	%		11.43	%		14.81	%
Escrow credit spread		5.16	%		4.85	%		4.71	%		4.74	%		4.94	%		5.12	%		5.07	%		4.96	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, expect per share amounts)
(Unaudited)

(8) MORTGAGE SERVICING RIGHTS (continued)

A valuation allowance is established for the excess of the cost of each residential mortgage servicing asset stratum over its estimated fair value. Activity in the valuation allowance for mortgage servicing rights for the ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 consisted of the following (in thousands):

Balance as of December 31, 2006 $ 1,222
Write-offs of reserves (65 )
Decrease in valuation allowance for mortgage servicing rights (656 )

Balance as September 30, 2007 $ 501


Balance as of December 31, 2007	$	1,473
Decrease in valuation allowance for mortgage servicing rights		(1,134	)

Balance as June 30, 2008	$	339

~~For~~In the ~~three-month and nine-month periods ended September 30, 2007,~~first quarter of 2008, Sovereign recorded a residential mortgage servicing ~~fee income was $10.5 million and $30.7 million, compared with $8.9 million and $21.6~~right impairment charge of $18.7 million for the ~~corresponding periods~~three-month period ended March 31, 2008, which was driven by lower interest rates and higher market prepayment speed assumptions. In the second quarter of 2008, Sovereign recovered $19.8 million of its total impairment reserve as a result of normalization in ~~the prior year.~~market prepayment speed assumptions as CPR speeds declined to 12.19% at June 30, 2008 compared to 20.64% at March 31, 2008.

Sovereign had gains/(losses)~~/gains~~ on the sale of mortgage loans, ~~multifamily~~multi-family loans and home equity loans of ~~$6.4~~$14.7 million and ~~$(88.4)~~$27.9 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007,~~2008, compared with ~~$14.7~~$9.1 million and ~~$27.6~~$(94.7) million for the corresponding periods ended ~~September~~June 30, ~~2006.~~2007. The loss ~~recorded for the nine month period ended September 30,~~in 2007 is a result of a $119.9 million ~~charge~~of losses recorded on the Company’s correspondent home equity loans. Sovereign had planned on selling $4.3 billion of correspondent home equity loans as of December 31, 2006. However, we were not able to sell $658 million of loans and as a result wrote them down to fair value incurring a charge of $84.2 million which was recorded within mortgage banking revenue. In addition, Sovereign also established a reserve for any potential loan repurchases that may result from certain representation and warranty clauses contained within the sale agreement. Finally, we were required to further write down the loans that we sold in the first quarter due to lower pricing on the execution of the sales which resulted from increases in delinquencies on the loan portfolio since year-end and lower pricing in the market place for non-prime loans. The total charge recorded in connection with these two items was $35.7 million.

Included in the mortgage banking revenue totals above was a loss of $5.4 million and a gain of $5.1 million, respectively for the three-month and nine-month periods ended September 30, 2007 related to a commercial real estate and multifamily loans that are intended to be sold and/or were sold during 2007. See Note 12 for additional discussion.portfolio.

Sovereign also originates and sells ~~multifamily~~multi-family loans in the secondary market to Fannie Mae while retaining servicing. At ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, Sovereign serviced ~~$10.3~~$12.2 billion and ~~$8.0~~$10.9 billion, respectively, of loans for Fannie Mae and as a result has recorded servicing assets of ~~$21.9~~$18.6 million and $20.4 million, respectively. Sovereign recorded servicing asset amortization of ~~$7.7~~$1.9 million and $3.5 million related to the ~~multifamily~~multi-family loans sold to Fannie Mae for the three-month and six-month periods ended June 30, 2008 and recognized servicing assets of ~~$6.7~~$5.9 million during the first ~~nine~~six months of ~~2007.~~2008. Additionally, due to lower escrow credit rate assumptions and increased prepayment speed assumptions since year-end, Sovereign has recorded a multi-family servicing right net impairment charge of $4.2 million for the six-month period ended June 30, 2008.

(9) BUSINESS SEGMENT INFORMATION

During the first quarter of 2008, as previously discussed in Sovereign’s 2008 first quarter Form 10-Q, certain changes to our executive management were announced such as the hiring of a new head of Retail Banking and a new Chief Financial Officer. In addition, Sovereign centralized the responsibility for the major businesses within the Company naming a new head of Retail, Commercial Lending, Corporate Specialty Businesses and Corporate Support Services. The head of these business units report directly to the Chief Executive Officer and, along with our Chief Financial Officer and Chief Risk Officer, comprise the Executive Management Group. These events changed how our executive management team measures and assesses business performance. During the second quarter we finalized the process of updating our business unit profitability system to reflect our new organizational structure.

As a result of the changes discussed above, Sovereign now has four reportable segments. The Company’s segments are focused principally around the customers Sovereign serves. The Retail Banking Division is comprised of our branch locations. Our branches offer a wide range of products and services to customers and each attracts deposits by offering a variety of deposit instruments including demand and NOW accounts, money market and savings accounts, certificates of deposits and retirement savings plans. Our branches also offer certain consumer loans such as home equity loans and other consumer loan products. The Corporate Specialties Group segment is primarily comprised of our mortgage banking group, our New York multi-family and national commercial real estate lending group, our automobile dealer floor plan lending group and our indirect automobile lending group. It also provides capital market services and cash management services. The Commercial Lending segment provides the majority of Sovereign’s commercial lending platforms such as commercial real estate loans, commercial industrial loans, leases to commercial customers and small business loans. The Other segment includes earnings from the investment portfolio, interest expense on Sovereign’s borrowings and other debt obligations, minority interest expense, amortization of intangible assets and certain unallocated corporate income and expenses.

2119

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, ~~except~~expect per share amounts)
(Unaudited)

~~(11) RECENT ACCOUNTING PRONOUNCEMENTS~~

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (FAS 157), which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. As a result of FAS 157 there is now a common definition of fair value to be used throughout GAAP. This new standard is intended to make the measurement for fair value more consistent and comparable and improve disclosures about those measures. The statement does not require any new fair value measurement but will result in increased disclosures. This interpretation is effective for fiscal years beginning after November 15, 2007. Sovereign will adopt this interpretation on January 1, 2008.

On February 15, 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (FAS 159). This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in FAS 159 are elective; however, the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities.

The fair value option established by FAS 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments.

FAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Sovereign will adopt this pronouncement on January 1, 2008 and is currently evaluating whether it will elect to carry any assets or liabilities at fair value.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars in thousands, except per share amounts)~~
~~(Unaudited)~~

~~(12)~~(10) INTERESTS THAT CONTINUE TO BE HELD BY SOVEREIGN IN ASSET SECURITIZATIONS

As described more fully in its annual report filed on Form 10-K, Sovereign has securitized certain financial assets to qualified special purpose entities which were deconsolidated in accordance with FAS 140.

During the ~~second~~first quarter of ~~2007,~~2008, Sovereign ~~executed~~exercised its cleanup call option on its securitized mortgage loan portfolio. This did not have a commercial mortgage backed securitization which consisted of approximately $687.7 million of multi-family loans and $327.0 million of commercial real estate loans. Sovereign retained certain subordinated certificates issued in connection with the securitization which were valued in the market place at approximately $15.6 million as well as certain servicing responsibilities for the assets that were sold. In connection with this transaction, Sovereign recorded a pretax gain of $13.8 million in the second quarter of 2007, which is included in mortgage banking revenues. This gain was determined based on the carrying amount of the loans sold, including any related allowance for loan loss, and was allocated to the loans sold and the retained interests based on their relative fair values at the sale date. The value of the retained subordinated certificates is subject to credit and prepayment risk. In accordance with SFAS No. 140, the subordinated certificates are classified in investments available for salesignificant impact on our Consolidated Balance Sheet. The investors have no recourse to the Company’s other assets, other than the retained subordinated certificates, to serve as additional collateral to protect their interests in the securitization.consolidated statement of operations or financial condition.

Shown below are the types of assets underlying the securitizations for which Sovereign owns and continues to own an interest in and the related balances and delinquencies at ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, and the net credit losses for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007~~2008 and the year ended December 31, ~~2006~~2007 (in thousands):


	September 30, 2007							December 31, 2006							June 30, 2008						December 31, 2007
				Principal		Net				Principal		Net					Principal		Net				Principal		Net
	Total			90 Days		Credit		Total		90 Days		Credit			Total		90 Days		Credit		Total		90 Days		Credit
	Principal		��	Past Due		Losses		Principal		Past Due		Losses			Principal		Past Due		Losses		Principal		Past Due		Losses
Mortgage Loans	$	14,070,940		$	119,607	$	1,745	$	17,480,841	$	101,448	$	8,782		$	11,856,434	$	180,085	$	9,482	$	13,397,822	$	130,101	$	7,498
Home Equity Loans and Lines of Credit		6,168,057			87,830		3,037		9,574,735		125,253		448,526	(1)		6,598,027		97,708		11,666		6,300,558		88,848		11,063
Commercial Real Estate and Multi-family Loans		16,841,278			56,265		8,387		—		—		—			17,943,548		144,265		43,095		17,526,885		57,623		15,540
Automotive Floor Plan Loans		1,100,357			—		838		1,389,164		—		—			1,176,478		8,998		2,039		1,255,729		—		335


Total Owned and Securitized	$	38,180,632		$	263,702	$	14,007	$	28,444,740	$	226,701	$	457,308		$	37,574,487	$	431,056	$	66,282	$	38,480,994	$	276,572	$	34,436


Less:
Securitized Mortgage Loans	$	61,049		$	732	$	30	$	76,111	$	383	$	17		$	—	$	—	$	—	$	56,629	$	638	$	30
Securitized Home Equity Loans		109,913			17,017		2,154		131,175		14,907		3,322			93,289		14,973		1,916		103,410		15,764		2,915
Commercial Real Estate and Multi-family Loans		981,294			—		—		—		—		—
Securitized Commercial Real Estate and Multi-family Loans																958,964		—		—		973,601		—		—
Securitized Automotive Floor Plan Loans		855,000			—		838		855,000		—		—			855,000		—		2,039		855,000		—		335


Total Securitized Loans	$	2,007,256		$	17,749	$	3,022	$	1,062,286	$	15,290	$	3,339		$	1,907,253	$	14,973	$	3,955	$	1,988,640	$	16,402	$	3,280


Net Loans	$	36,173,376		$	245,953	$	10,985	$	27,382,454	$	211,411	$	453,969		$	35,667,234	$	416,083	$	62,327	$	36,492,354	$	260,170	$	31,156

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, ~~except~~expect per share amounts)
(Unaudited)

~~(12)~~(10) INTERESTS THAT CONTINUE TO BE HELD BY SOVEREIGN IN ASSET SECURITIZATIONS (continued)

At ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, key economic assumptions and the sensitivity of the fair value of the retained interests to immediate 10 percent and 20 percent adverse changes in those assumptions are as follows (dollars in thousands):


				Home											Home
				Equity						Commercial					Equity						Commercial
				Loans &			Auto			Loans					Loans &			Auto			Loans
	Mortgage			Lines of			Floor			Secured by					Lines of			Floor			Secured by
	Loans			Credit			Plan Loans			Real Estate			Total		Credit			Plan Loans			Real Estate			Total
Interests that continue to be held by Sovereign:
Accrued interest receivable	$	—		$	—		$	5,681		$	—		$	5,681	$	—		$	3,448		$	—		$	3,448
Subordinated interest retained		15,945			—			43,996			15,628			75,569		—			43,996			6,867			50,863
Servicing rights		920			245			—			—			1,165
Interest only strips		—			6,739			1,010			—			7,749		2,223			1,010			—			3,233
Cash reserve		—			—			4,381			—			4,381		—			4,381			—			4,381


Total Interests that continue to be held by Sovereign	$	16,865		$	6,984		$	55,068		$	15,628		$	94,545	$	2,223		$	52,835		$	6,867		$	61,925


Weighted-average life (in yrs)		0.28			1.67			0.27			9.72					3.42			0.41			8.07
Prepayment speed assumption (annual rate)
As of the date of the securitization		40	%		22	%		50	%		10	%				22	%		50	%		10	%
As of December 31, 2006		40	%		19	%		46	%		—
As of September 30, 2007		40	%		18	%		53	%		10	%
As of December 31, 2007																17	%		49	%		10	%
As of June 30, 2008																13	%		43	%		10	%
Impact on fair value of 10% adverse change	$	—		$	(61	)	$	(90	)	$	—				$	(148	)	$	(42	)	$	—
Impact on fair value of 20% adverse change	$	—		$	(121	)	$	(144	)	$	—				$	(299	)	$	(92	)	$	—
Expected credit losses (annual rate)
As of the date of the securitization		0.12	%		0.75	%		0.25	%		0.05	%				0.75	%		.25	%		.50	%
As of December 31, 2006		0.12	%		1.95	%		0.25	%		—
As of September 30, 2007		0.12	%		3.74	%		0.25	%		0.05	%
As of December 31, 2007																5.25	%		.25	%		.50	%
As of June 30, 2008																3.74	%		.25	%		.60	%
Impact on fair value of 10% adverse change	$	(2	)	$	(124	)	$	(34	)	$	(159	)			$	(382	)	$	(42	)	$	(60	)
Impact on fair value of 20% adverse change	$	(3	)	$	(232	)	$	(68	)	$	(318	)			$	(740	)	$	(84	)	$	(119	)
Residual cash flows discount rate (annual)
As of the date of the securitization		9	%		12	%		8	%		12	%				12	%		8	%		12	%
As of December 31, 2006		9	%		12	%		8	%		—
As of September 30, 2007		9	%		12	%		8	%		12	%
As of December 31, 2007																12	%		8	%		17	%
As of June 30, 2008																12	%		8	%		28	%
Impact on fair value of 10% adverse change	$	(2	)	$	(57	)	$	(81	)	$	(338	)			$	(90	)	$	(95	)	$	(91	)
Impact on fair value of 20% adverse change	$	(4	)	$	(124	)	$	(163	)	$	(663	)			$	(174	)	$	(191	)	$	(178	)

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, ~~except~~expect per share amounts)
(Unaudited)

~~(13) ADOPTION OF FASB INTERPRETATION NO. 48~~(11) UNRECOGNIZED TAX BENEFITS

~~Sovereign adopted the provisions of FASB Interpretation No. 48,~~~~Accounting for Uncertainty in Income Taxes,~~on January 1, 2007. As a result of the implementation of Interpretation 48, the Company recognized a $0.9 million decrease in the liability for unrecognized tax benefits, which was accounted for as an increase to the January 1, 2007, balance of retained earnings. On January 1, 2007,At June 30, 2008, Sovereign had net unrecognized tax benefit reserves related to uncertain tax positions of ~~$67.2~~$92.1 million. Of this amount, approximately ~~$10.7~~$13.7 million related to reserves established for uncertain tax positions from the acquisition of Independence. Any adjustments to these reserves in future periods will be adjusted through ~~goodwill.~~goodwill prior to the effective date of SFAS 141(R). After SFAS 141(R) becomes effective, (which for Sovereign will be January 1, 2009) any adjustments to reserves associated with the Independence acquisition or other acquisitions will be required to be recorded through earnings as an adjustment to Sovereign’s income tax provision. The remaining balance of ~~$56.5~~$78.4 million represents the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate.

~~Sovereign’s unrecognized tax benefit reserve increased $8.4 million during~~ A reconciliation of the ~~nine-month period ended September 30, 2007 to $75.6 million as a result of $10.0 million~~beginning and ending amount of unrecognized tax benefits ~~related to uncertain tax positions taken during the nine-month period ended September 30, 2007 offset by a $1.6 million reduction~~is as ~~a result of a lapse of the applicable statute of limitations.~~follows:


	(in thousands)
Gross unrecognized tax benefits at December 31, 2007	$	87,461
Additions based on tax positions related to the current year		10,861
Additions based on tax positions related to prior years (1)		16,847
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations		(1,142	)

Gross unrecognized tax benefits at June 30, 2008		114,027
Less: Federal, state and local income tax benefits		21,884

Net unrecognized tax benefits at June 30, 2008		92,143
Less: Unrecognized tax benefits included above that relate to acquired entities that would impact goodwill if recognized		13,708

Total unrecognized tax benefits that, if recognized, would impact the effective income tax rate as of June 30, 2008	$	78,435


(1)		Includes additional reserves of $16.0 million ($10.4 million, net of tax) recorded in the second quarter of 2008 to increase reserves for uncertain tax positions based on recent rulings in certain states.

Sovereign recognizes penalties and interest accrued related to unrecognized tax benefits within income tax expense on the Consolidated Statement of Operations. During the ~~nine-month period~~three-month and six-month periods ended ~~September~~June 30, ~~2007,~~2008, Sovereign recognized approximately ~~$2.3~~$4.6 million and ~~for the years ended December 31, 2006, and 2005, the Company recognized approximately $1.7 million and $0.8~~$5.9 million, respectively, in interest and ~~penalties. The Company had~~penalties compared to $2.1 million and $4.0 million, respectively, for the corresponding periods in the prior year. Included in gross unrecognized tax benefits at June 30, 2008 was approximately ~~$5.4~~$14.7 million for the potential payment of interest and ~~penalties accrued at September 30, 2007.~~penalties.

Sovereign is subject to the income tax laws of the United States, its states and municipalities and certain foreign countries. These tax laws are complex and are potentially subject to different interpretations by the taxpayer and the relevant Governmental taxing authorities. In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of these inherently complex tax laws.

Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. Sovereign reviews its tax balances quarterly and as new information becomes available, the balances are adjusted, as appropriate. The Company is subject to ongoing tax examinations and assessments in various jurisdictions. The Internal Revenue Service (the “IRS”) is currently examining the Company’s federal income tax returns for the years 2002 through 2005. The Company anticipates that the IRS will complete this review in the second half of 2008. Included in this examination cycle are two separate financing transactions with an international bank totaling $1.2 billion, which are discussed in Note 12 in the Company’s Form ~~10K.~~10-K. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and ~~during the nine-month period ended September 30,~~ 2007, Sovereign ~~accrued~~was subject to an additional $87.6 million and ~~$21.9~~$22.5 million, respectively, of foreign taxes ~~from this~~related to these financing ~~transaction~~transactions and claimed a corresponding foreign tax credit. ItWhile the IRS audit is ~~possible~~not complete, recent developments in our IRS audit leads us to expect that the IRS ~~may challenge~~will propose to disallow the ~~Company’s ability to claim these~~ foreign tax credits taken in 2003-2005 in the amount of $154.0 million related to these transactions and ~~could disallow the credits and~~to assess interest and potential penalties, ~~related~~the combined amount of which totaled approximately $73.4 million as of June 30, 2008. In addition, while the IRS has not yet initiated an audit for the years 2006 and 2007, we expect that in the future the IRS will propose to disallow the foreign tax credits taken in 2006 and 2007 of $87.6 million and $22.5 million, respectively, and to assess interest and potential penalties, the combined amount of which totals approximately $16.9 million as of June 30, 2008. Sovereign may need to litigate this ~~transaction.~~matter with the IRS. Sovereign believes that it is entitled to claim these foreign tax credits and also believes that its recorded tax reserves for this position of ~~$56.1~~$58.7 million adequately provides for any ~~liabilities~~potential exposure to the IRS related to foreign tax credits and other tax assessments. However, as the ~~completion of~~Company continues to go through the IRS ~~review~~administrative process, and ~~their conclusion on Sovereign’s~~if necessary litigation, we will continue to evaluate the appropriate tax ~~positions included in the tax returns~~reserve levels for ~~2002 through 2005 could result in an adjustment~~this position and any changes made to the tax ~~balances and~~ reserves ~~that have been recorded and~~ may materially affect Sovereign’s income tax provision, net income and regulatory capital in future periods.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars in thousands, except per share amounts)~~
~~(Unaudited)~~

~~(14) RELATED PARTY TRANSACTIONS (continued)~~

��2007. Related party loans at ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006~~2007 also included consumer loans secured by residential real estate of ~~$3.4~~$1.4 million and ~~$4.8~~$3.4 million, respectively, to executive officers and directors of Sovereign Bancorp.

Related party loans do not include undrawn commercial and consumer lines of credit that totaled ~~$1.6~~$1.2 million and ~~$66.5~~$1.3 million at ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, respectively. ~~The decline is due to the reduction in the number of Bank directors.~~

The Company is engaged in certain activities with Meridian Capital due to its acquisition of Independence. Meridian Capital is deemed to be a “related party” of the Company as such term is defined in SFAS No. 57 since Sovereign has a 35% minority equity investment in Meridian Capital, which is 65% owned by Meridian Funding, a ~~New-York based~~New York-based mortgage firm. Meridian Capital refers and receives fees from borrowers seeking financing of their multi-family and/or commercial real estate loans to Sovereign as well as to numerous other financial institutions. Sovereign recognized ~~$3.6~~$2.5 million and ~~$7.5~~$4.9 million, respectively, of income due to its investment in Meridian Capital for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, 2008 compared to $2.4 million and $3.9 million, respectively, for the three-month and six-month periods ended June 30, 2007. Additionally, substantially all of Sovereign’s multi-family loan originations are obtained via our relationship with Meridian Capital. Sovereign recognized gains on the sale of multi-family loans of $9.7 million and $18.9 million, respectively, for the three-month and six-month periods ended June 30, 2008 and $5.7 million and $16.3 million, respectively, for the three-month and six-month periods ended June 30, 2007.

As discussed in Note 163 in Sovereign’s ~~2006~~2007 Form 10-K, Sovereign raised $2.4 billion of equity by issuing 88.7 million shares to Banco Santander Central Hispano (“Santander”), which makes Santander the largest shareholder and a related party. Per the terms of Sovereign’s investment agreement with Santander, Sovereign is permitted to have at least three Santander employees on its payroll, and Santander is permitted to have at least three Sovereign employees on its payroll.

In 2006, Santander extended a total of $425 million in unsecured lines of credit to the Bank for federal funds and Eurodollar borrowings and for the confirmation of standby letters of credit issued by the Bank. These lines are at a market rate and in the ordinary course of business and can be cancelled by either the Bank or Santander at any time and can be replaced by the Bank at any time. AsDuring the second quarter of ~~September 30, 2007,~~2008, the average balance outstanding was ~~$204.5~~$203.4 million, which consisted entirely of standby letters of credit. As of ~~September~~June 30, ~~2007,~~2008, there was no outstanding balance on the unsecured lines of credit for federal funds and Eurodollar borrowings. The Bank paid approximately ~~$0.4~~$0.6 million in fees ~~and $0.5 million in interest~~ to Santander for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007~~2008 in connection with these commitments.

In May 2006, Santander’s capital markets group, Santander Investment Securities, Inc., received approximately $800,000 in underwriting discounts in connection with Sovereign’s capital market initiatives to fund the acquisition of Independence. Also, per the terms of Sovereign’s investment agreement with Santander, Sovereign is permitted to have at least three Santander employees on its payroll, and Santander is permitted to have at least three Sovereign employees on its payroll.

In February 2007, Sovereign entered into an agreement with Isban U.K., Ltd. (“Isban”), an information technology subsidiary of Santander, under which Isban performed a review of, and ~~recommend~~recommended enhancements to, Sovereign’s banking information systems. Sovereign has paid Isban ~~$475,000,~~$0.5 million, excluding expenses, for this review. In June 2007, Sovereign and Isban entered into an agreement whereby Isban will provide Sovereign certain consulting services through December 31, 2008. Sovereign has agreed to pay Isban $2.2 million, excluding expenses for these services.

As discussed in Note 6,12 of our 2007 Form 10-K, Sovereign issued $300 million of senior notes during the first quarter of 2007 and Santander was a co-issuer of this issuance. Santander received underwriting fees of $37,500 in connection with this transaction.

2724

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, ~~except~~expect per share amounts)
(Unaudited)

~~(15) RESTRUCTURING COSTS AND OTHER CHARGES~~(13) FAIR VALUE

As ~~more fully~~ discussed in Note 15, “Recent Accounting Pronouncements”, to the Consolidated Financial Statements Sovereign adopted SFAS No. 159 on its residential mortgage loans classified as held for sale that were originated subsequent to January 1, 2008 which allows us to record our mortgage loan held for sale portfolio at fair market value versus the lower of cost or market. Sovereign hedges its residential held for sale portfolio with forward sale agreements which are reported at fair value under SFAS No. 133. We historically did not apply hedge accounting to this loan portfolio because of the complexity of these accounting provisions. Under our historical lower of cost or market accounting treatment, we were unable to record the excess of our fair market value over book value but were required to record the corresponding reduction in value on our hedges. Under SFAS No. 159, both the loans and related hedges are carried at fair value which reduces earnings volatility as the amounts more closely offset, particularly in environments when interest rates are declining.

Sovereign’s ~~2006 Form 10-K, Sovereign’s management completed a comprehensive review~~residential loan held for sale portfolio had an aggregate fair value of ~~Sovereign’s operating cost structure~~$313.2 million at June 30, 2008. The contractual principal amount of these loans totaled $316.1 million. The difference in fair value compared to principal balance of $2.9 million was recorded in mortgage banking revenues during the six-month period ended June 30, 2008. Substantially all of these loans are current and none are in non-accrual status. Interest income on these loans is credited to interest income as earned. The fair value of these loans is estimated based upon the anticipated exit price for these loans in the ~~fourth quarter~~secondary market to agency buyers such as Fannie Mae and Freddie Mac. Practically our entire residential loan held for sale portfolio is sold to these two agencies.

The most significant instruments that the Company fair values include investment securities, derivative instruments and loans held for sale. The majority of ~~2006. During~~ the ~~first quarter of 2007, Sovereign finalized a decision to close or consolidate approximately 40 underperforming branch locations. This action was executed~~securities in the ~~second quarter~~Company’s available for sale portfolios are priced via independent providers, whether those are pricing services or quotations from market-makers in the specific instruments. In obtaining such valuation information from third parties, the Company has evaluated the valuation methodologies used to develop the fair values in order to determine whether such valuations are representative of ~~2007. As a result, Sovereign wrote down~~an exit price in the Company’s principal markets. The Company’s principal markets for its investment securities are the secondary institutional markets with an exit price that is predominantly reflective of bid level pricing in these markets.

Currently, the Company uses derivative instruments to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs.

To comply with the provisions of SFAS No. 157, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurement of its derivatives. In adjusting the fair value of the fixed assets and recorded other charges at these locations of $22.5 million during the nine-month period ended September 30, 2007. Sovereign also terminated additional employees in 2007, resulting in severance charges of $13.7 millionits derivative contracts for the ~~nine-month period ended September~~effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings and guarantees.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of June 30, ~~2007. These charges are included in restructuring, other employee severance and debt extinguishment charges~~2008, the Company has assessed the significance of the impact of the credit valuation adjustments on the ~~consolidated income statement~~overall valuation of its derivative positions and ~~recorded~~has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in ~~the Other segment. A rollforward~~their entirety are classified in Level 2 of the ~~restructuring and severance accrual is summarized below:~~

Contract
termination Severance Other Total
Accrued at December 31, 2006 $ 7,043 $ 45,930 $ 5,906 $ 58,879
Payments (7,183 ) (48,829 ) (8,908 ) (64,920 )
Charges recorded in earnings 16,007 13,668 6,093 35,768

Accrued at September 30, 2007 $ 15,867 $ 10,769 $ 3,091 $ 29,727

fair value hierarchy. The Company does not have any fair value measurements for derivatives using significant unobservable input (Level 3) as of June 30, 2008.

~~Sovereign’s executive management team and Board of Directors elected to freeze~~When estimating the Company’s Employee Stock Ownership Plan (ESOP) and communicated this decision to its employee base during the first quarter of 2007. During the second quarter of 2007, the debt owed by the ESOP was repaid with the proceeds from the sale of a portion of the unallocated shares held by the ESOP and all remaining shares were allocated to the eligible participants. During the first quarter of 2007, Sovereign recorded a non-deductible non-cash charge of $43.4 million in connection with this action based on thefair value of its common stock at March 31, 2007. In the second quarter, the charge was adjusted based on the final price of Sovereign’s common stock on the date that the ESOP was repaid which reduced the previous charge recordedloans held for sale portfolio, interest rates and general conditions in the ~~first quarter by $3.3 million.~~

~~Sovereign incurred pre-tax charges of $14.3 million of proxy and related professional fees~~principal markets for the loans are the most significant underlying variables that will drive changes in the ~~nine months ended September 30, 2006. These fees were related to certain advertisements and legal and professional fees incurred in connection with~~fair values of the ~~Relational Investors LLC (“Relational”) matter. Due to~~loans, not borrower-specific credit risk since substantially all of the ~~settlement with Relational, the Company does not anticipate any additional significant costs related to this matter.~~loans are current.

2825

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, ~~except~~expect per share amounts)
(Unaudited)

(13) FAIR VALUE (continued)

The following table presents the assets that are measured at fair value on a recurring basis by level within the fair value hierarchy (see Note 15 for further information on the fair value hierarchy) as reported on the consolidated balance sheet at June 30, 2008. As required by SFAS No. 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement (in thousands).


	Fair Value Measurements at Reporting Date Using:
	Quoted Prices in
	Active Markets for		Significant Other			Significant		Balance at
	Identical Assets		Observable Inputs			Unobservable		June 30,
	(Level 1)		(Level 2)			Inputs (Level 3)		2008
Assets:
US Treasury and government agency securities	$	—	$	66,296		$	—	$	66,296
Debentures of FHLB, FNMA and FHLMC		—		22,331			—		22,331
Corporate debt and asset-backed securities		—		53,370			458,040		511,410
Equity securities		—		16,586			588,171		604,757
State and municipal securities		—		2,417,826			—		2,417,826
Mortgage backed securities		—		6,338,223			1,157,341		7,495,564

Total investment securities available for sale		—		8,914,632			2,203,552		11,118,184
Loans held for sale		—		469,189			—		469,189
Derivatives		—		(165,711	)		—		(165,711	)
Mortgage servicing rights		—		—			181,129		181,129
Other assets		—		44,417			3,448		47,865

Total	$	—	$	9,262,527		$	2,388,129	$	11,650,656

Sovereign’s Level 3 assets are primarily comprised of CDO’s, FNMA/FHLMC preferred stock and certain non-agency mortgage backed securities. These investments are thinly traded and, in certain instances, Sovereign is the sole investor in these securities. Sovereign receives third party broker quotes for these securities to determine their estimated fair value. These quotes are benchmarked against similar securities that are more actively traded in order to assess the reasonableness of the estimated fair values. The fair market value estimates we assign to these securities assume liquidation in an orderly fashion and not under distressed circumstances. Due to the continued illiquidity and credit risk of certain securities, the market value of these securities is highly sensitive to assumption changes and market volatility.

The table below presents the changes in our Level 3 balances since year-end (in thousands).


	Investments			Mortgage
	Available			Servicing			Other
	for Sale			Rights			Assets			Total
Balance at December 31, 2007	$	2,700,513		$	162,623		$	7,104		$	2,870,240
Gains/(losses) in other comprehensive income		(382,813	)		—			—			(382,813	)
Gains/(losses) in earnings		(4,381	)		(3,086	)		—			(7,467	)
Purchases/Additions		104			42,449			—			42,553
Repayments		(109,871	)		—			(735	)		(110,606	)
Sales/Amortization		—			(20,857	)		(2,921	)		(23,778	)

Balance at June 30, 2008	$	2,203,552		$	181,129		$	3,448		$	2,388,129

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, expect per share amounts)
(Unaudited)

(14) LEGAL CONTINGENCIES

Except as discussed below, Sovereign is not involved in any pending material legal proceeding other than routine litigation occurring in the ordinary course of business. Sovereign does not expect that any amounts that it may be required to pay in connection with these routine litigation matters would have a material adverse effect on its financial position.

In January 2008, the Company received a letter from a purported shareholder demanding an investigation into the Board of Director’s oversight of several public disclosures made by the Company from June 2006 through January 2008, contending primarily that the Company inadequately disclosed its exposure to changes in the consumer credit market. The Board, with the assistance of independent counsel, is in the process of analyzing the issues raised in the demand letter.

In the first quarter of 2008, a former employee filed a putative class action in Pennsylvania federal court alleging that the Company violated ERISA in connection with the management of certain plans. The plaintiff alleges that the Company knew or should have known that the Company’s stock was not a prudent investment for the Company’s retirement plan beginning on or about January 1, 2007. The complaint also alleges that the Company provided the putative class and the investing community with inadequate disclosure concerning the Company’s financial condition, resulting in the stock having an inflated value until the Company’s disclosures in January 2008. In April 2008, a similar putative class action was filed in the same court by another former employee. The complaint in the second action asserts that the Company caused retirement plan assets to be invested in the Company’s stock when it was imprudent to do so, caused the plan to purchase the stock while not disclosing alleged financial problems and to pay above market interest rates for a Company loan, and failed to provide complete and accurate information to participants in the plan. In July 2008, counsel for the respective plaintiffs filed a consolidated amended complaint that expanded upon the allegations set forth in the prior two actions. The class period in the consolidated amended complaint was also expanded to include the period from January 1, 2002 to present. The Company believes that the claims are without merit and intends to vigorously defend the claims.

In the first quarter of 2008 a voluntary mediation was held in connection with a claim made against Sovereign related to an investment advisor in Massachusetts who defrauded numerous victims over a long period of time. The fraud reportedly amounted to tens of millions of dollars. The investment advisor’s companies had accounts at Sovereign. The court appointed an ancillary receiver to pursue claims against Sovereign and another bank, and the ancillary receiver filed a complaint against Sovereign. Some of the victims joined in the action as plaintiffs, and some of the claims are putative class action claims. The ancillary receiver recently filed a motion seeking class certification. Little progress was made towards a settlement at the voluntary mediation that was held in the first quarter of 2008 and the trial is currently scheduled to begin in September 2008. The Company believes the claims are without merit and intends to vigorously defend the claims.

(15) RECENT ACCOUNTING PRONOUNCEMENTS

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157,Fair Value Measurements(“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, SFAS No. 157 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, expect per share amounts)
(Unaudited)

(15) RECENT ACCOUNTING PRONOUNCEMENTS (continued)

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

Sovereign’s adoption of SFAS No. 157 did not have a significant impact on its financial condition or results of operations. See further discussion and analysis of Sovereign’s adoption of SFAS No. 157 in Note 13.

In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS 159”), which allows entities, at specified election dates, to choose to measure certain financial instruments at fair value that are not currently required to be measured at fair value. The fair value option is applied on an instrument-by-instrument basis, is irrevocable and can only be applied to an entire instrument and not to specified risks, specific cash flows, or portions of that instrument. Unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings at each subsequent reporting date and upfront fees and costs related to those items will be recognized in earnings as incurred and not deferred. SFAS No. 159 is effective in fiscal years beginning after November 15, 2007 and may not be applied retrospectively. Effective January 1, 2008, Sovereign adopted SFAS No. 159 on residential mortgage loans classified as held for sale that were originated subsequent to January 1, 2008. See further discussion and analysis of Sovereign’s adoption of this standard at Note 13.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141R”). The new pronouncement requires the acquiring entity in a business combination to recognize only the assets acquired and liabilities assumed in a transaction (for example, acquisition costs must be expensed when incurred), establishes the fair value at the date of acquisition as the initial measurement for all assets acquired and liabilities assumed, including contingent consideration, and requires expanded disclosures, SFAS 141(R) will be effective for fiscal years beginning after December 15, 2008. Early adoption is prohibited. Sovereign does not expect the adoption of this pronouncement to have a material impact to its financial statements.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements and Amendment of ARB No. 51” (“SFAS No. 160”). The new pronouncement requires all entities to report noncontrolling (minority) interests in subsidiaries as a component of shareholders’ equity. SFAS No. 160 will be effective for fiscal years beginning after December 15, 2008. Early adoption is prohibited. Management does not anticipate that this statement will have a material impact on Sovereign’s financial condition and results of operations.

In March 2008, the FASB issued SFAS No. 161,“Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133(“SFAS 161”), which requires enhanced disclosures about an entity’s derivative and hedging activities intended to improve the transparency of financial reporting. Under SFAS 161, entities will be required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. Sovereign will adopt SFAS 161 effective January 1, 2009.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, expect per share amounts)
(Unaudited)

(16) ~~PURCHASE OF INDEPENDENCE~~SUBSEQUENT EVENT

Sovereign closed on its acquisition of Independence effective June 1, 2006 for $42 per share in cash, representing an aggregate transaction value of $3.6 billion. Sovereign funded this acquisition using the proceeds from the $2.4 billion equity offering to Santander, net proceeds from issuances of perpetual and trust preferred securities and cash on hand. Sovereign issued 88,705,123 shares to Santander, which made Santander its largest shareholder. Independence was headquartered in Brooklyn, New York, with 125 community banking officesIn late July 2008, a syndicated loan in the ~~five boroughs~~commercial loan portfolio declared bankruptcy. It appears the entity may have engaged in some high-risk business practices which caused a sudden liquidity crisis and ultimately led to the bankruptcy. Sovereign’s total exposure to this entity is approximately $73 million. Sovereign’s exposure is collateralized by accounts receivable, inventory, and fixed assets. The Company is in the process of ~~New York City, Nassau~~gathering more facts about this situation and ~~Suffolk Counties and New Jersey. Sovereign acquired Independence to connect their Mid-Atlantic geographic footprint to New England and create new markets in certain areas of New York. In connection~~is working with the ~~Independence acquisition, Sovereign recorded charges against its earnings for~~lead bank and our consultants to determine the ~~three-month and nine-month periods ended September 30, 2006 for merger related expenses~~appropriate course of ~~$25.9 million and $32.2 million pre-tax, respectively.~~

~~The purchase price was allocated~~action to mitigate any potential losses. Accordingly, at this point the loss severity, if any, on this loan cannot be determined. However, to the ~~acquired assets and assumed liabilities of Independence based on estimated fair value as of June 1, 2006. (dollars in millions):~~

Assets
Investments $ 3,126.5
Loans:
Multifamily 5,571.2
Commercial 5,313.3
Consumer 517.2
Residential 1,829.0

Total loans 13,230.7
Less allowance for loan losses (97.8 )

Total loans, net 13,132.9

Cash acquired, net of cash paid (2,713.2 )
Premises and equipment, net 167.9
Bank Owned Life Insurance 343.3
Other assets 370.5
Core deposit and other intangibles 394.2
Goodwill 2,280.6

Total assets $ 17,102.7

Liabilities
Deposits:
Core $ 6,960.8
Time 4,070.1

Total deposits 11,030.9
Borrowings and other debt obligations 5,488.8
Other liabilities (1) 583.0

Total liabilities $ 17,102.7


~~(1)~~		Includes liabilities of $26.2 million directly associated with the transaction which were recorded as part of the purchase price which is primarily comprised of $14.4 million of termination penalties for canceling certain long-term Independence contracts related to redundant services and $2.8 million related to branch consolidation.

~~The status of reserves~~extent that this matter is not resolved favorably, Sovereign’s third quarter results could include a significant charge-off related to ~~the Independence acquisition is summarized below (in thousands):~~

Reserve balance at December 31, 2006 $ 22,432
Charge recorded in earnings 2,242
Payments (18,676 )

Reserve balance at September 30, 2007 $ 5,998

this one loan.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

EXECUTIVE SUMMARY

Sovereign is a financial institution with ~~$87 billion in total assets and~~ community banking offices, operations and team members located principally in Pennsylvania, Massachusetts, New Jersey, Connecticut, New Hampshire, New York, Rhode Island, Maryland, and Delaware. Sovereign gathers substantially all of its deposits in these market areas. We use these deposits, as well as other financing sources, to fund our loan and investment portfolios. We earn interest income on our loans and investments. In addition, we generate non-interest income from a number of sources including: deposit and loan services, sales of residential, home equity, and multi-family loans and investment securities, capital markets products, cash management products, and bank owned life insurance. Our principal non-interest expenses include employee compensation and benefits, occupancy and facility related costs, technology and other administrative expenses. Our volumes, and accordingly our financial results, are affected by various factors including the economic environment ~~including~~and its affect on interest rates, consumer and business confidence and spending, as well as competitive conditions within our geographic footprint.

~~We are one of the 20 largest banking institutions in the United States as measured by total assets.~~ Our customers select Sovereign for banking and other financial services based on our ability to assist customers by understanding and anticipating their individual financial needs and providing customized solutions. Our major strengths ~~include:~~include a strong franchise value in terms of market share and ~~demographics;~~demographics and diversified loan portfolio and ~~products; and the ability to internally generate equity through earnings.~~products. Our weaknesses have included operating returns and capital ratios that are lower than certain of our peers. We have also not achieved our growth targets with respect to low cost core deposits.

~~Management is in~~We took proactive steps during the process of implementing strategies to address these weaknesses. Management completed a comprehensive review of Sovereign’s operating cost structure, and has substantially completed the implementation of a restructuring plan, which was approved by Sovereign’s Board of Directors in the fourthsecond quarter of 2006. The restructuring plan focused on a number of strategies which helped to strengthen our capital position and related capital ratios which decreased following the Independence acquisition and improved our financial performance. Management has developed the following key initiatives to deliver improved quality of earnings, provide greater transparency and understanding of Sovereign’s businesses and strategy, and better position Sovereign for sustainable growth:

~~1. Improve productivity and expense management;~~

~~2. Improve the capital position and quality of earnings; and~~

~~3. Improve the customer experience.~~

Our productivity and expense management initiative focused on eliminating functional redundancies and improving operating inefficiencies by deemphasizing products/business lines not meeting profit or strategic goals, leveraging economies of scale with vendor supply and service contracts, optimizing capacity utilization and expenses associated with facilities, consolidating departments and optimizing retail delivery channels while minimizing the impact on customer facing activities and organic revenue generation. Management identified approximately $100 million of expense reductions involving consolidation of support groups, exit of business lines performing below expectations, contract renegotiations, and a reduction in workforce.

In December 2006, Sovereign notified approximately 360 employees that their positions had been eliminated. Furthermore, we terminated additional employees in 2007, resulting in year to date severance charges of $13.7 million. We also closed approximately 40 underperforming branch locations to date in 2007. In connection with the decision to close these locations, Sovereign recorded charges of $22.5 million in the nine-month period ended September 30, 2007. We intend to continue to make investments in our retail franchise and we have opened or relocated 16 new branches year to date and are targeting the opening or relocation of approximately 20 new branch offices in more desirable locations during the remainder of this year and into 2008.

~~In order~~2008 to improve our capital position ~~Sovereign sold approximately $8.0~~by raising $1.4 billion of ~~low margin and/or high credit risk assets~~common equity and ~~reduced our wholesale fundings significantly~~$500 million of subordinated debt at Sovereign Bank. As a result of the capital raise, net income of $127.4 million in the ~~first~~second quarter, ~~of 2007 with~~and a reduction in the ~~proceeds from the sales. These loan sales enhanced the quality~~size of our balance sheet ~~improved the quality of our earnings, and enhanced~~by $2.7 billion, our capital ratios ~~while repositioning Sovereign~~improved significantly during the second quarter. Tangible Common Equity to Tangible Assets and Tier 1 Leverage for ~~sustainable growth~~the Parent Company increased at June 30, 2008 to 6.04% and 8.34% from 3.81% and 6.21% at March 31, 2008, respectively. The Bank’s total risk based capital ratio increased to 11.41% from 10.24%. These capital levels and ratios are now in ~~core earnings~~line with our peers and significantly in excess of the levels required to be considered well-capitalized. We have also reduced wholesale funding sources, improved our operating metrics and increased our tangible book value per share over the ~~long-term.~~

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion~~past two quarters. We continue to strengthen our balance sheet and ~~Analysis of Financial Condition and Results of Operations (continued)~~position the Company for any further weakening in economic conditions.

~~Sovereign’s strategy is~~In order to ~~acquire~~further improve our operating returns, we continue to focus on acquiring and ~~retain~~retaining customers by demonstrating convenience through our locations, technology and business approach while offering innovative and easy-to-use products and ~~service.~~services. We are focused on a number of initiatives to improve the customer experience. ~~Customer~~During 2007, customer service personnel ~~are receiving~~received refresher service training and we ~~have~~ migrated back to having all customer service functions bebeing domestically based. We ~~are realigning~~realigned our consumer and commercial infrastructure by consolidating our commercial and retail ~~on-line~~ banking management structure. We ~~have~~ also rationalized and simplified our retail deposit product set by reducing the number of retail checking products we offer.

In the fourth quarter of 2007, we ~~will be implementing~~piloted a new retail deposit strategy called “Customer First” in certain markets within our footprint. The goal of ~~this strategy will be~~Customer First is to increase deposit retention and growth rates and increase the number of products and services our customers maintain and use at Sovereign. ~~After the initial phase~~Customer First, which is a sales model/methodology that drives consistent team member behavior in each of ~~this program is completed, we hope to implement it~~our 750 community banking offices, was implemented throughout our entire branch network in the first quarter of 2008. We are seeing improved productivity within retail banking and improved deposit retention. Additionally, in the first quarter of 2008, Sovereign hired a senior level executive who reports to our Chief Executive Officer to lead the Company’s Retail Banking Division. We believe these two steps helped stabilize our deposit base thus far in 2008, as average retail and commercial deposits increased to $38.7 billion for the second quarter of 2008, compared to $38.1 billion at year-end and $37.5 billion a year ago.

RECENT INDUSTRY CONSOLIDATION IN OUR GEOGRAPHIC FOOTPRINT

The Banking industry has experienced significant consolidation in recent years. Consolidation may affect the markets in which Sovereign operates as new or restructured competitors integrate acquired businesses, adopt new business practices or change product pricing as they attempt to maintain or grow market share. Recent merger activity involving national, regional and community banks and specialty finance companies in the northeastern United States, ~~including acquisitions by Sovereign,~~ have affected the competitive landscape in the markets we serve. ~~Sovereign acquired Independence on June 1, 2006, and we believe this acquisition will strengthen our franchise.~~ Management continually monitors the environment in which it operates to assess the impact of the industry consolidation on Sovereign, as well as the practices and strategies of our competition, including loan and deposit pricing, customer expectations and the capital markets.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~

CREDIT RISK ENVIRONMENT

The credit quality of our loan portfolio has ~~had~~ a significant impact on our operating ~~results for 2007. Any significant change in the credit quality of our loan portfolio would have a significant effect on our financial position and results of operations.~~results. We have experienced a deterioration in certain key credit quality performance indicators that began in the ~~third~~second half of 2007 that has continued through the first half of 2008 which has resulted in higher levels of charge-offs and provision for credit losses. For the second quarter of 2008, the provision for credit losses and charge-offs were $132.0 million and $86.9 million, respectively, compared to $51.0 million and $25.7 million in the second quarter of 2007, respectively. Our provision for credit losses and charge-offs for the six-month period ended June 30, 2008 were $267.0 million and $161.2 million compared to $97.0 million and $49.8 million, respectively, for the corresponding period in the prior year. These negative trends persist throughout the majority of our loan portfolios. As of June 30, 2008 total non-performing loans were $490.5 million or 0.85% of total loans compared to $291.5 million or 0.52% at June 30, 2007. ~~Particularly, we needed to~~The increase ~~the allowance for~~in non-performing loans was primarily driven by our residential Alt-A, commercial real estate, multi-family and commercial and industrial loan ~~losses to cover higher expected losses on our~~portfolios.

During 2007, Sovereign expanded its indirect auto loan portfolio ~~due to increased loss rates recently experienced on this portfolio. This resulted~~into the Southeastern and Southwestern United States (“out-of-market loans”). Sovereign originated $2.8 billion of out-of-market loans in ~~an increase to~~2007 at a weighted average yield of 8.04%. However, credit losses were higher than our ~~provision of $37 million during the third quarter of 2007. See further discussion~~expectations for those new originations. Effective January 31, 2008, Sovereign ceased originating new auto loans from these markets. We also strengthened our underwriting standards in the ~~section titled “Provision for Credit Losses” for additional details.~~

~~As discussed previously, there were approximately $658 million of correspondent home equity loans that we did not sell during our restructuring in the first quarter~~second half of 2007 and are now holding for investment. The loans were marked to market at March 31, 2007 which considered the credit risk at that time associated with the loans. Many of these correspondent home equity loans were non-prime loans. The non-prime market has been impacted by declines in housing values and a reduction in the number of mortgage lenders and has shown increasing levels of delinquencies and charge offs. The actual losses on the remaining correspondent home equity portfolio have been higher than originally estimated as a result of changing market conditions during the third quarter of 2007. As of September 30, 2007, we concluded that our existing reserves needed to be increased by $47 million to cover higher inherent losses for this loan portfolio at this time. However, if the housing market deteriorates further and or delinquencies or loss rates rise, Sovereign could be required to record additional provisions for credit losses for this portfolio in future periods. See further discussion in the section titled “Provision for Credit Losses” for additional details.

The homebuilder industry has been impacted by a decline in new home sales and a reduction in the value of residential real estate which has decreased the profitably of these companies and resulted in liquidity issues for certain companies. Sovereign provides financing to various homebuilder companies which is included in our commercialentire auto loan portfolio. We believe ~~our existing reserve levels are adequate to cover~~these two decisions will lower loss rates in future periods; however, losses ~~for these loans. However, we will~~remained elevated thus far in 2008 as the newly originated loans continue to ~~monitor this portfolio~~season. Losses in 2008 have been in line with our forecast; however, deterioration in the economy of the regions where we extended these loans could have a significant adverse impact on the amount of credit losses we experience in future ~~periods given recent market conditions and determine the impact, if any, on the allowance~~periods. The remaining balance of our auto out-of-market loan portfolio at June 30, 2008 was $2.2 billion with reserves for ~~loan~~credit losses ~~related to these homebuilder loans.~~

~~RESULTS OF OPERATIONS~~

~~General~~

Net income was $58.2 million, or $0.11 per diluted share, and $253.7 million, or $0.51 per diluted share, for the three-month and nine-month periods ended September 30, 2007 as compared to $184.0 million, or $0.37 per diluted share, and $266.4 million, or $0.62 per diluted share, for the three-month and nine-month periods ended September 30, 2006.

~~During the first quarter, as previously discussed, the Company’s Board~~ of Directors approved management’s decision to close/consolidate approximately 40 underperforming branches. During the nine-month period ended September 30, 2007, Sovereign recorded charges of $22.5 million related to the decision to write-down to fair value the fixed assets at these locations and to accrue for the present values of the remaining lease obligations, net of the estimated fair value of sub-leasing these properties. The fair value sublease estimate was derived by comparing current market lease rates for comparable properties. If the actual proceeds from any subleases on these properties are different than our estimate, then the difference will be reflected as either an additional restructuring expense or a reversal thereof.

In mid-December, Sovereign notified approximately 360 employees that their positions had been eliminated. Furthermore, we terminated additional employees in 2007, resulting in year to date severance charges of $13.7$86.1 million.

3231

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

~~Sovereign’s executive management team~~As discussed previously, conditions in the housing market significantly impacted areas of our business. Certain segments of our consumer and ~~Board~~commercial loan portfolios have exposure to the housing market. Sovereign has residential real estate loans totaling $11.9 billion at June 30, 2008 of ~~Directors decided~~which $2.8 billion is comprised of Alt-A residential loans. Although losses have been increasing since the prior year, actual credit losses on these loans have been modest and totaled $4.6 million and $9.5 million during the three-month period and six-month period ended June 30, 2008 compared to ~~freeze~~$1.6 million and $2.1 million for the ~~Company’s Employee Stock Ownership Plan (ESOP)~~corresponding periods in the prior year. However non-performing assets and ~~communicated~~past due loans have been increasing particularly for the Alt-A portion of the residential portfolio. The increased loss experience and asset quality trends led us to increase our reserves for our residential portfolio over the past three quarters. Future losses in our residential loan portfolio will continue to be significantly influenced by home prices in the residential real estate market, unemployment and general economic conditions.

Sovereign also has $6.1 billion of home equity loans and lines of credit (excluding our correspondent home equity loans). Net charge-offs on these loans for the three-month and six-month periods ended June 30, 2008 were $4.4 million and $9.8 million, respectively, compared with $1.9 million and $3.5 million for the corresponding periods in the prior year. This portfolio consists of loans with an average FICO at origination of 714 and an average loan to value of 66%. We have total reserves of $32.2 million for this ~~decision~~loan portfolio at June 30, 2008.

During the first half of 2008, we continued to ~~its employee base~~experience increases in non-performing assets in our commercial lending and commercial real estate portfolios. Non-performing assets for these portfolios increased to $129.7 million and $117.3 million at June 30, 2008 from $85.4 million and $61.8 million at December 31, 2007. Given these changes, we increased our allowance for loan losses for these portfolios by approximately $93.7 million during the first ~~quarter~~half of ~~2007. During the second quarter~~2008. This increase was a significant component of 2007, the debt owed by the ESOP was repaid with the proceeds from the sale of a portion of the unallocated shares held by the ESOP and all remaining shares were allocated to the eligible participants. During the first quarter of 2007, Sovereign recorded a non-deductible non-cash charge of $43.4 million in connection with this action based on the value of our common stock at March 31, 2007. In the second quarter, the charge was adjusted based on the final price of our common stock on the date that the ESOP was repaid which reduced the previous charge recorded in the first quarter by $3.3 million.

As part of the restructuring plan, Sovereign redeemed certain asset backed floating rate notes and junior subordinated debentures due to Capital Trust Entities totaling approximately $1.0 billion. In connection with these transactions, Sovereign incurred debt extinguishment charges of $14.7 million during the nine-months ended September 30, 2007. Sovereign believes these actions will improve net income in future periods as the financings were higher cost borrowings.

~~In the third quarter of 2007, Sovereign recorded a~~ provision for credit losses of ~~$162.5~~$132.0 million and $267.0 million for the three-month and six-month periods ended June 30, 2008. A large portion of these increases is tied to companies that are in housing related industries. We have decreased the amount of loan originations to these borrower types in 2008; however, we expect that the difficult housing environment as well as deteriorating economic conditions will continue to impact our commercial lending and commercial real estate portfolios which may result in elevated levels of provisions for credit losses in future periods.

RESULTS OF OPERATIONS

General

Net income was $127.4 million, or $0.22 per diluted share, and $227.6 million, or $0.42 per diluted share, for the three-month and six-month periods ended June 30, 2008 as compared to ~~$45.0~~$147.5 million, or $0.29 per diluted share, and $195.5 million, or $0.39 per diluted share for the three-month and six-month periods ended June 30, 2007. Net income in ~~the third quarter~~2007 included charges of ~~2006 due primarily~~$216.0 million ($140.4 million after-tax or $0.27 per diluted share) related to ~~increased~~our 2007 balance sheet restructuring and an expense saving initiative. Current year results include an elevated provision for credit losses ~~related~~compared with the corresponding periods in the prior year due to ~~our correspondent home equity~~the slowing economic conditions and ~~indirect auto~~the deterioration in most categories of our loan portfolios ~~previously discussed.~~

~~During the third quarter of 2007, Sovereign recorded charges of $19.4 million related~~as discussed above. The provision for credit losses has increased to ~~losses on repurchase agreement and market value contracts provided to a number of mortgage companies who defaulted on their obligations. This charge was recorded in capital markets revenues.~~

~~In the third quarter of 2007, Sovereign recorded lower of cost or market write downs of $5.4~~$132.0 million and ~~$6.2~~$267.0 million ~~on its commercial real estate/multifamily loan portfolio and its commercial and industrial loan syndication portfolios due to widening credit spreads~~ in the ~~market place since~~three-month and six-month periods ended June 30, ~~2007. These charges were recorded in mortgage banking revenues~~2008 compared to $51.0 million and commercial banking fees, respectively. In the second quarter of 2007, Sovereign sold $1.0 billion of multi-family and commercial real estate loans as part of the CMBS securitization which resulted in a gain of $13.8 million which is recorded in mortgage banking revenues. See Note 12 for further discussion.

In the first quarter of 2007, Sovereign sold $2.9 billion of residential loans, $1.3 billion of multi-family loans and $3.4 billion of correspondent home equity loans. As discussed previously, we were not able to sell $658 million of loans and as a result wrote them down to fair value incurring a charge of $84.2$97.0 million for the three-month ~~period~~and six-month periods ended ~~March 31,~~June 30, 2007 which was recorded within mortgage banking revenue. In addition to this charge, Sovereign also established a reserve for any potential loan repurchases that may result from certain representation and warranty clauses contained within the sale agreement. We also were required to further write down the loans that we sold in the first quarter due to ~~lower pricing on~~ the ~~execution~~impact of the ~~sales which resulted from~~slowing economy and the deterioration of ~~the~~credit quality in our loan portfolio since year-end and lower pricing in the market place for non-prime loans. The total charge recorded in connection with these two items was $35.7 million for the three-month period ended March 31, 2007. The total charge related to the correspondent home equity loan sale of $119.9 million in 2007 is reflected in mortgage banking income/(loss).

During the three-month period ended June 30, 2006, following the acquisition of Independence (discussed in Note 16), Sovereign sold $3.5 billion of investment securities with a combined effective yield of 4.40% for asset/liability management purposes, to maintain compliance with its existing interest rate policies and guidelines and to offset, in part, the negative effect of the current yield curve on net interest margin for future periods. As a result, we incurred a pre-tax loss of $238.3 million ($154.9 million after-tax or $0.36 per share). Of the total $3.5 billion of investments sold, $1.8 million had been previously classified as held-to-maturity, and Sovereign recorded a pre-tax loss of $130.1 million related to the sale of the held-to-maturity securities. As a result of the sale of the held-to-maturity securities, Sovereign concluded that it was required to reclassify the remaining $3.2 billion of held-to-maturity investment securities to the available-for-sale investment category.

During the three-month period ended June 30, 2006, Sovereign also recorded other-than-temporary impairment charges of $67.5 million on FNMA and FHLMC preferred stock. Sovereign determined that certain unrealized losses on perpetual preferred stock of FNMA and FHLMC was other-than-temporary in accordance with SFAS 115 “Accounting for Certain Investments in Debt and Equity Securities” and the SEC’s Staff Accounting Bulletin No. 59 “Accounting for Non-current Marketable Equity Securities”. The Company’s assessment considered the duration and the severity of the unrealized loss, the financial condition and near-term prospects of the issuers, and the likelihood of the market value of these instruments increasing to our initial cost basis within a reasonable period of time based upon the anticipated interest rate environment. As a result of these factors, Sovereign concluded that the unrealized losses were other-than-temporary and recorded a non-cash impairment charge.portfolios.

3332

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

CONSOLIDATED AVERAGE BALANCE SHEET / TAX EQUIVALENT NET INTEREST MARGIN ANALYSIS
~~NINE-MONTH~~SIX-MONTH PERIOD ENDED ~~SEPTEMBER~~JUNE 30, ~~2007~~2008 AND ~~2006~~2007
(in thousands)


	2007								2006								2008								2007
				Tax								Tax								Tax								Tax
	Average			Equivalent		Yield/			Average			Equivalent		Yield/			Average			Equivalent		Yield/			Average			Equivalent		Yield/
	Balance			Interest		Rate			Balance			Interest		Rate			Balance			Interest		Rate			Balance			Interest		Rate
EARNING ASSETS INVESTMENTS LOANS:	$	14,359,545		$	662,500		6.15	%	$	14,281,351		$	610,934		5.71	%
EARNING ASSETS
INVESTMENTS																	$	12,571,679		$	384,816		6.13	%	$	14,605,167		$	446,257		6.12	%
LOANS:
Commercial loans		25,169,599			1,361,906		7.23	%		19,699,524			1,051,982		7.14	%		27,461,417			810,910		5.93	%		25,037,502			896,922		7.21	%
Multi-Family		4,827,663			232,677		6.43	%		2,748,477			126,583		6.14	%		4,411,480			132,892		6.03	%		5,260,766			170,970		6.51	%
Consumer loans
Residential mortgages		14,788,758			630,279		5.68	%		15,053,802			636,131		5.63	%		12,935,327			366,113		5.66	%		15,007,930			426,604		5.69	%
Home equity loans and lines of credit		7,122,383			369,186		6.93	%		10,110,555			488,104		6.45	%		6,303,688			184,741		5.89	%		7,705,765			267,154		6.98	%

Total consumer loans secured by real estate		21,911,141			999,465		6.09	%		25,164,357			1,124,235		5.96	%		19,239,015			550,854		5.74	%		22,713,695			693,758		6.13	%

Auto loans		5,915,010			307,332		6.95	%		4,400,416			192,228		5.84	%		6,767,900			234,243		6.96	%		5,558,312			189,007		6.86	%
Other		376,740			24,156		8.57	%		460,455			27,826		8.08	%		310,151			11,996		7.78	%		405,150			17,114		8.52	%

Total consumer		28,202,891			1,330,953		6.30	%		30,025,228			1,344,289		5.98	%		26,317,066			797,093		6.08	%		28,677,157			899,879		6.30	%

Total loans		58,200,153			2,925,536		6.71	%		52,473,229			2,522,854		6.42	%		58,189,963			1,740,895		6.00	%		58,975,425			1,967,771		6.71	%
Allowance for loan losses		(496,921	)		—		—			(471,358	)		—		—			(753,763	)		—		—			(484,122	)		—		—

NET LOANS		57,703,232			2,925,536		6.77	%		52,001,871			2,522,854		6.48	%		57,436,200			1,740,895		6.08	%		58,491,303			1,967,771		6.76	%

TOTAL EARNING ASSETS		72,062,777			3,588,036		6.65	%		66,283,222			3,133,788		6.31	%		70,007,879			2,125,711		6.09	%		73,096,470			2,414,028		6.63	%
Other assets		11,632,426			—		—			9,623,451			—		—			10,358,340			—		—			11,665,137			—		—

TOTAL ASSETS	$	83,695,203		$	3,588,036		5.72	%	$	75,906,673		$	3,133,788		5.51	%	$	80,366,219		$	2,125,711		5.31	%	$	84,761,607		$	2,414,028		5.72	%


FUNDING LIABILITIES
Deposits and other customer related accounts:
Core deposits and other related accounts	$	29,021,996		$	667,159		3.07	%	$	25,684,728		$	507,832		2.64	%
Time deposits		15,521,792			564,388		4.86	%		13,784,845			442,893		4.30	%
Retail and commercial deposits																	$	31,977,082		$	420,002		2.64	%	$	31,013,559		$	460,616		3.00	%
Wholesale deposits																		3,583,218			49,035		2.75	%		7,850,548			212,361		5.45	%
Government deposits																		3,538,526			49,870		2.83	%		3,830,241			97,401		5.13	%
Customer repurchase agreements																		2,655,607			24,742		1.87	%		2,326,334			52,489		4.55	%

TOTAL DEPOSITS		44,543,788			1,231,547		3.70	%		39,469,573			950,725		3.22	%		41,754,433			543,649		2.62	%		45,020,682			822,867		3.69	%

BORROWED FUNDS:
FHLB advances		16,280,973			614,962		5.04	%		15,715,567			528,095		4.49	%		18,307,665			419,306		4.59	%		16,155,849			404,590		5.03	%
Fed funds and repurchase agreements		1,342,104			53,546		5.33	%		1,528,668			58,590		5.12	%		1,131,420			16,125		2.87	%		1,451,213			38,748		5.38	%
Other borrowings		4,785,627			218,863		6.10	%		4,942,265			200,476		5.41	%		3,710,284			110,599		5.97	%		5,318,968			159,332		6.00	%

TOTAL BORROWED FUNDS		22,408,704			887,371		5.29	%		22,186,500			787,161		4.74	%		23,149,369			546,030		4.73	%		22,926,030			602,670		5.28	%

TOTAL FUNDING LIABILITIES		66,952,492			2,118,918		4.23	%		61,656,073			1,737,886		3.77	%		64,903,802			1,089,679		3.37	%		67,946,712			1,425,537		4.22	%
Demand deposit accounts		6,381,978			—		—			5,826,134			—		—			6,537,456			—		—			6,378,845			—		—
Other liabilities		1,585,747			—		—			1,342,011			—		—			1,657,959			—		—			1,660,284			—		—

TOTAL LIABILITIES		74,920,217			2,118,918		3.78	%		68,824,218			1,737,886		3.37	%		73,099,217			1,089,679		2.99	%		75,985,841			1,425,537		3.78	%
STOCKHOLDERS’ EQUITY		8,774,986			—		—			7,082,455			—		—			7,267,002			—		—			8,775,766			—		—

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	83,695,203			2,118,918		3.38	%	$	75,906,673			1,737,886		3.06	%	$	80,366,219			1,089,679		2.72	%	$	84,761,607			1,425,537		3.39	%

NET INTEREST INCOME				$	1,469,118							$	1,395,902							$	1,036,032							$	988,491

NET INTEREST SPREAD (1)							2.42	%							2.54	%							2.72	%							2.41	%


NET INTEREST MARGIN (2)							2.72	%							2.81	%							2.97	%							2.71	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Net Interest Income

Net interest income for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007~~2008 was ~~$456.8~~$506.1 million and ~~$1.4 billion~~$988.3 million compared to ~~$491.8~~$453.4 million and ~~$1.3 billion~~$941.2 million for the same periods in ~~2006.~~2007. The ~~year to date~~ increase in net interest income was due to ~~growth~~an increase in net interest margin for the three-month and six-month periods ended June 30, 2008 to 3.06% and 2.97%, compared to the corresponding periods in the prior year of 2.71% and 2.71%. The reason for the increase has been due to the recent steepening of the yield curve, the balance sheet restructuring we executed in the first quarter of 2007 and reductions in short-term interest rates which has benefited us given our mildly liability sensitive interest rate position. Partially offsetting this positive impact in net interest income was a decrease in average interest earning assets to ~~$72.1~~$69.5 billion and $70.0 billion for the ~~nine-month period~~three-month and six-month periods ending ~~September~~June 30, ~~2007~~2008 compared to ~~$66.3~~$70.3 billion and $73.1 billion for the ~~nine-month period~~three-month and six-month periods ending ~~September~~June 30, 2006. The increase is due to the Independence acquisition as well as strong growth in commercial and auto loans. Partially offsetting this increase was a decrease in net interest margin for the nine-month period ended September 30, 2007 to 2.72%, compared to the corresponding period in the prior year of 2.81%, resulting from the flattening yield curve, which became inverted during the first quarter of 2006 and whose spread has continued to remain under pressure. Additionally, low-cost core deposit growth has not kept pace with our loan growth and as a result ~~loan growth has been funded~~of the sale of $3.4 billion, $2.9 billion and $1.2 billion of correspondent home equity, residential mortgage loans and multi-family loans, respectively, in connection with ~~higher cost borrowings which has put pressure on~~ our net interest margin. The decrease in net interest income for the three-month period ended September 30, 2007 compared to the corresponding period in the prior year is due to a reduction in average earning assets of $7.8 billion. This reduction was due to the previously discussed balance sheet restructuring ~~that was finalized~~ in the first quarter of 2007. Although we have reduced our exposure to these loan categories, Sovereign has been focused on generating commercial loan growth within its geographic footprint which has led to an increase of approximately $2.4 billion of average commercial loans.

Interest on investment securities and interest earning deposits was ~~$196.1~~$163.8 million and ~~$602.1~~$344.7 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007, respectively,~~2008, compared to ~~$221.5~~$195.6 million and ~~$556.0~~$405.9 million for the same periods in ~~2006.~~2007. The average balance of investment securities was ~~$14.4~~$12.6 billion with an average tax equivalent yield of ~~6.15%~~6.13% for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007~~2008 compared to an average balance of ~~$14.3~~$14.6 billion with an average yield of ~~5.71%~~6.12% for the same period in ~~2006.~~2007. The ~~increase~~decrease in ~~yield is primarily due to a rise in market interest rates and~~average balances was due to the ~~investment restructuring Sovereign executed in the second and fourth quarters of 2006.~~2007 balance sheet restructuring.

Interest on loans was ~~$954.0~~$838.0 million and ~~$2.9~~$1.7 billion for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007, respectively,~~2008, compared to ~~$1.0 billion~~$943.9 million and ~~$2.5~~$2.0 billion for the three-month and ~~nine-month~~six-month periods in ~~2006.~~2007. The average balance of loans was $58.2 billion with an average yield of ~~6.71%~~6.00% for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007~~2008 compared to an average balance of ~~$52.5~~$59.0 billion with an average yield of ~~6.42%~~6.71% for the same period in ~~2006.~~2007. Average balances of commercial loans in ~~2007~~2008 increased ~~$5.5~~$2.4 billion as compared to ~~2006~~2007, primarily due to strong organic growth in our commercial loan ~~portfolio and the impact of loans acquired from Independence.~~portfolio. Commercial loan yields have ~~increased 9~~decreased 128 basis points due to the ~~rise~~decline in short-term interest rates which has ~~particularly increased~~decreased the yields on our variable rate loan products. Average residential mortgages decreased ~~$265 million~~$2.1 billion due to the sale of $2.9 billion of residential loans in the first quarter ~~offset by an increase in loans due to the Independence acquisition.~~of 2007. Average home equity loans and lines of credit decreased ~~$3.0~~$1.4 billion from the prior year due to the sale of $3.4 billion of ~~these~~correspondent home equity loans in connection with the previously mentioned balance sheet restructuring at the end of the first quarter of 2007.

~~Sovereign also acquired a $5.6~~ Average multi-family loans decreased $0.8 billion ~~multi-family loan portfolio~~ from ~~Independence whose average balance totaled $4.8 billion in~~ the ~~nine-month period ended September 30, 2007. Sovereign sold~~prior year due to the sale of $1.3 billion of multi-family loans in the first quarter of ~~2007 and approximately $688 million in the second quarter of 2007 as a part of the CMBS securitization.~~2007. Average balances of auto loans increased to ~~$5.9~~$6.8 billion from ~~$4.4~~$5.6 billion due to organic in-market growth and a ~~recent~~ decision towards the middle of 2006 to expand loan production offices in the Southeastern and Southwestern United States (“the Southwest and Southeast production offices”). The Southeast and Southwest production offices have significantly contributed to the growth in auto loan balances and these loan portfolios comprise approximately 35% of our outstanding auto loan portfolio and approximately 61% of our 2007 auto loan originations.out-of-market loans. However, as previously discussed, losses on these loans have been higher than our expectations and ~~resulted~~effective January 31, 2008, management ceased originating loans from these channels. This has led to a reduction of average auto loans in ~~an increase in our provision for loan losses~~the second quarter of ~~$37 million~~2008 as this portfolio declined to $6.6 billion for the ~~third quarter of 2007. We have made adjustments~~three-month period ended June 30, 2008 compared to ~~our underwriting standards which we believe will improve~~$7.0 billion for the ~~overall profitability of this loan portfolio in the future.~~three-month period ended March 31, 2008.

Interest on deposits and related customer accounts was ~~$408.7~~$228.5 million and ~~$1.2 billion~~$543.6 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007, respectively,~~2008, compared to ~~$412.9~~$409.6 million and ~~$950.7~~$822.9 million for the same periods in ~~2006.~~2007. The average balance of deposits was ~~$44.5~~$41.8 billion with an average cost of ~~3.70%~~2.62% for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007~~2008 compared to an average balance of ~~$39.5~~$45.0 billion with an average cost of ~~3.22%~~3.69% for the same period in ~~2006. Additionally, the~~2007. The average balance of non-interest bearing demand deposits ~~has~~ increased tofrom $6.4 billion ~~at September 30,~~in 2007 ~~from $5.8~~to $6.5 billion ~~for the same period~~ in ~~the prior year.~~2008. The ~~increase~~decrease in ~~the balance of total deposits~~average cost is due primarily to decreases in costlier wholesale deposit categories due to ~~the addition of deposits~~our 2007 balance sheet restructuring and a de-emphasis on wholesale financings as well as a reduction in connection with the Independence acquisition. Also contributing to the increase is time deposit and money market growth which has become a more favorable funding alternative as costs on shorter term borrowing obligations continue to increase.short-term interest rates.

Interest on borrowed funds was ~~$284.7~~$267.1 million and ~~$887.4~~$546.0 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007, respectively,~~2008, compared to ~~$336.2~~$276.4 million and ~~$787.2~~$602.7 million for the same periods in ~~2006.~~2007. The average balance of borrowings was ~~$22.4~~$23.1 billion with an average cost of ~~5.29%~~4.73% for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007~~2008 compared to an average balance of ~~$22.2~~$22.9 billion with an average cost of ~~4.74%~~5.28% for the same period in ~~2006.~~2007. The decrease in average cost has been due to a reduction in market interest rates. This benefit has been partially offset by our callable advance borrowings with the FHLB (which is discussed below) as well as, to a lesser extent, the impact of our recent $500 million subordinated debt issuance which has effective yield of 8.92%.

3534

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Sovereign currently has a series of callable advances totaling $2.6 billion with the FHLB. These advances provide variable ~~rate~~ funding (currently at ~~3.88%~~4.84%) during the non-call period which ranges from 6 to 18 months. The majority of these advances are past their non- call periods. After the non-call period, the interest rates on these advances ~~resets~~reset to a fixed rate of interest with certain caps (ranging from 4.95% to 5.50%) and floors of 0%. ~~Based on the current interest rate environment, these instruments may be called by the FHLB upon the expiration of the non-call period.~~ If these advances are not called by the FHLB, they would mature on various dates ranging from August 2012 to September 2016.

Provision for Credit Losses

The provision for credit losses is based upon credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the current loan portfolio. The provision for credit losses for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007~~2008 was ~~$162.5~~$132.0 million and ~~$259.5~~$267.0 million, ~~respectively,~~ compared to ~~$45.0~~$51.0 million and ~~$118.5~~$97.0 million for the same periods in ~~2006.~~2007. The provision for credit losses for the ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 includes a higher level of provision versus ~~2006~~2007 due to several factors as discussed below.

During the third quarter of 2007, management concluded that the existing credit reserves related to the $658 million of correspondent home equity loans that were not sold at March 31, 2007 were not adequate to cover losses for this portfolio. Management based this determination from actual loss and prepayment experience on this remaining portfolio since March 31, 2007. The actual loss experience has been higher than originally estimated and has been impacted by decreases in housing values and a reduction of in the number of lenders making loans in the sub-prime market. In the third quarter, management considered this recent loss experience and the impact of market conditions on the remaining correspondent home equity portfolio and updated the credit scores and loan to value ratios of the remaining loans due to certain price declines in residential real estate during the second and third quarters of 2007. Utilizing this updated data, we revised the anticipated credit losses for the remaining portfolio of $492.6 million and increased the credit reserves to $77.1 million at September 30, 2007. This resulted in an additional provision for credit losses of $47 million for this portfolio for the third quarter. Sovereign believes that we have adequately provided for losses on this portfolio at this time; however, if the housing market continues to deteriorate further or if delinquencies or loss rates rise, Sovereign could be required to record additional provisions for credit losses in future periods.

During 2007, Sovereign’s outstanding auto loan portfolio increased from $4.8 billion at December 31, 2006 to $6.9 billion at September 30, 2007. The majority of this growth was obtained via the Southwest and Southeast production offices, which have had total originations of $2.4 billion year to date. The average yield on this portfolio was 8.14%, compared to 7.92% on our 2007 loan originations within our geographic footprint. Although credit losses were expected to be higher in the Southeast and Southwest, we saw an increase in losses during the third quarter in excess of what was expected. Management has made a number of operational changes and strengthened the underwriting standards for these loans to be consistent with the standards of our historical footprint. We believe this will decrease the loss experience on newly originated loans; however, we increased the overall allowance for loan loss on the auto loan portfolio by $37 million during the third quarter of 2007 to provide for additional credit losses anticipated to be incurred on loans that were originated by our Southwest and Southeast production offices prior to our recent underwriting changes.

~~In the third quarter of 2007,~~ Sovereign experienced further deterioration in the credit quality of certain commercial ~~loans.~~loans due to weakening market conditions, particularly those associated with residential construction companies. As a result of ~~market conditions,~~an increase in criticized and non-accrual loans and growth of $1.1 billion in our commercial real estate loans and commercial industrial loans, Sovereign ~~did a complete analysis of commercial loans that are provided to companies in~~increased the ~~mortgage industry (i.e. construction and homebuilder loans). Based on our review, we concluded that we needed to increase our~~ provision for credit losses in excess of charge-offs by ~~$19.6~~approximately $93.7 million for ~~the three-month period ended September 30, 2007 to cover the higher level of inherent losses for these loans.~~our commercial portfolio since year-end. Although we believe current levels of reserves are adequate to cover the inherent losses for these loans, future changes in housing values, interest rates and economic conditions could impact the provision for credit losses for these loans in future periods.

~~Net~~In late July 2008, a syndicated loan in the commercial loan portfolio declared bankruptcy. It appears the entity may have engaged in some high-risk business practices which caused a sudden liquidity crisis and ultimately led to the bankruptcy. Sovereign’s total exposure to this entity is approximately $73 million. Sovereign’s exposure is collateralized by accounts receivable, inventory, and fixed assets. The Company is in the process of gathering more facts about this situation and is working with the lead bank and our consultants to determine the appropriate course of action to mitigate any potential losses. Accordingly, at this point the loss severity, if any, on this loan can not be determined. However, to the extent that this matter is not resolved favorably, Sovereign’s third quarter results could include a significant charge-off related to this one loan.

Weakening credit conditions increased charge-offs for the ~~nine months~~three-month and six-month periods ended ~~September~~June 30, ~~2007 were $83.3~~2008 to $86.9 million and $161.2 million, respectively, compared to ~~$93.1~~$25.7 million and $49.8 million, respectively, for the ~~comparable period~~corresponding periods in the prior year. This equates to an annualized net loan charge-off to average loan ~~ratio~~ratios of ~~0.19%~~0.60% and 0.55% for the ~~nine months~~three-month and six-month periods ended ~~September~~June 30, ~~2007~~2008 compared to ~~0.24%~~0.18% and 0.17% for the comparable ~~period~~periods in the prior year. ~~However,~~The majority of the increase was related to our consumer loan portfolio including auto, residential mortgages and home equity loans. Sovereign’s auto charge-offs were $36.6 million and $79.4 million for the three-month and six-month periods ended June 30, 2008 compared to $12.3 million and $22.4 million for the corresponding periods in the prior year. As previously discussed, Sovereign significantly increased its auto loan portfolio, including an expansion of out-of-market loans in 2007. We stopped originating out-of-market loans effective January 31, 2008 due to unsatisfactory loss experience and also strengthened our underwriting standards in the second half of 2007 on our entire auto portfolio. We have also significantly curtailed auto loan originations in our geographic footprint in 2008 as second quarter loan originations totaled $239 million compared to $503 million last quarter, with the average FICO score improving to 745 from 718 a year ~~results include~~ago. The decision to reduce origination volumes and exit the out-of-market auto loan portfolio has reduced this portfolio to $6.3 billion at June 30, 2008 compared to $7.0 billion at December 31, 2007.

Correspondent home equity charge-offs ~~associated with~~were $6.2 million and $10.2 million for the three-month and six-month periods ended June 30, 2008. As discussed in our 2007 Form 10-K, Sovereign ceased originating this loan product in the first quarter of 2006 and made the decision to exit this portfolio in December 2006. Sovereign sold $3.4 billion of the loans in the first quarter of 2007, but decided to retain $658 million due to adverse market conditions. The Company wrote the loans that we retained down to fair value. At June 30, 2008, the remaining balance of the correspondent home equity portfolio was $416.1 million which consisted of ~~$38.3~~$308.2 million ~~or 0.10%.~~of first lien loans and $107.9 million of second lien loans with reserves for future credit losses of $51.2 million.

Although charge-off levels have been elevated on our indirect auto portfolio and our correspondent home equity portfolio, they have been within our expectations. Sovereign ~~sold the majority of this portfolio~~significantly increased reserve levels for these portfolios in ~~the first quarter and the remaining loans~~2007 in anticipation for losses that were inherent in the portfolio that have since been realized through charge-offs in 2008. We believe our remaining reserve levels are adequate to cover inherent losses in this portfolio; however, further deterioration in the regions of the U.S. economy where these loans were written down to fair value. Non-performing loans and non-performing assets at September 30, 2007 include $41.5 million of loans related to the remaining correspondent home equity portfolio. Non-performing assets were $336.7 million or 0.39% of total assets at September 30, 2007, compared to $221.6 million or 0.27% of total assets (excluding loans heldoriginated could result in additional credit quality deterioration that will require additional provisions for ~~sale) at December 31, 2006 and $273.1 million or 0.43% of total assets at September 30, 2006. Management regularly evaluates Sovereign’s loan portfolios, and its allowance for loan~~credit losses ~~and adjusts the loan loss allowance as deemed necessary.~~in future periods.

3635

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Non-performing assets were $553.9 million or 0.70% of total assets at June 30, 2008, compared to $361.6 million or 0.43% of total assets at December 31, 2007 and $334.0 million or 0.40% of total assets at June 30, 2007. The reason for the increase since year-end was primarily driven by our residential Alt-A, commercial real estate, multi-family and commercial and industrial loan portfolios. We factored in these increases when establishing our loan loss reserves at June 30, 2008 and it was one of the factors that caused our provision for credit losses to be elevated over the past few quarters. Management regularly evaluates Sovereign’s loan portfolios, and its allowance for loan losses, and adjusts the loan loss allowance as deemed necessary.

The following table presents the activity in the allowance for credit losses for the periods indicated (in thousands):


	Nine-Month Period Ended						Six-Month Period Ended
	September 30,						June 30,
	2007			2006			2008		2007
Allowance for loan losses, beginning of period	$	471,030		$	419,599		$	709,444	$	471,030

Charge-offs:
Commercial		41,934			33,036			53,988		27,613
Consumer secured by real estate		17,377			53,979			34,610		11,476
Consumer not secured by real estate		78,220			53,891			126,846		46,159


Total Charge-offs		137,531			140,906			215,444		85,248


Recoveries:
Commercial		9,689			8,587			5,639		6,156
Consumer secured by real estate		9,200			7,646			5,175		5,897
Consumer not secured by real estate		35,310			31,623			43,397		23,431


Total Recoveries		54,199			47,856			54,211		35,484


Charge-offs, net of recoveries		83,332			93,050			161,233		49,764
Provision for loan losses (1)		254,458			123,109			260,537		94,828
Allowance released in connection with loan sales		(12,409	)		(3,000	)		—		12,409
Acquired allowance for loan losses from business acquisitions		—			97,824


Allowance for loan losses, end of period	$	629,747		$	544,482			808,748		503,685

Reserve for unfunded lending commitments, beginning of period		15,255			18,212			28,301		15,255
Provision/(benefit) for unfunded lending commitments (1)		5,042			(4,609	)		6,463		2,172
Reserve for unfunded lending commitments, end of period		20,297			13,603			34,764		17,427

Total Allowance for credit losses	$	650,044		$	558,085		$	843,512	$	521,112

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

~~Non-Interest Income~~

~~Total non-interest income was $143.3~~ Commercial banking fees were $53.7 million and ~~$380.4~~$108.2 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007, respectively,~~2008, compared to ~~$201.0~~$52.0 million and ~~$172.3~~$101.5 million for the same periods in 2006. The previously discussed $119.9 million charge on the correspondent home equity loan portfolio negatively impacted our results for the nine month period ended September 30, 2007. Non-interest income for the nine month period ended September 30, 2006 includes the previously mentioned $238.3 million loss on sale2007, representing an increase of ~~investment securities~~3.3% and ~~an other-than-temporary impairment charge of $67.5 million on FNMA/FHLMC preferred stock.~~

Consumer banking fees were $73.1 million and $218.4 million for the three-month and nine-month periods ended September 30, 2007, respectively, compared to $74.3 million and $202.6 million for the same periods in 2006, representing a 2% decrease and an 8% increase,6.6%, respectively. The increase for the ~~nine months~~six-months ended ~~September~~June 30, ~~2007 was~~2008 is due primarily to growth in ~~loan~~deposit fees to ~~$7.8~~$41.1 million for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007~~2008 compared to ~~$3.4~~$27.4 million for the corresponding period in the prior ~~year~~year. This was partially offset by declines in income related to our precious metals lending business of $5.7 million due to ~~the acquisition of Independence as well as~~ a ~~gain of $2.7 million~~decision to focus on ~~the sale of $78.8 million of student loans which is included in~~relationships within our ~~results for the nine months ended September 30, 2007.~~core markets.

Commercial banking fees were $44.2 million and $145.6 million for the three-month and nine-month periods ended September 30, 2007, respectively, compared to $47.7 million and $130.7 million for the same periods in 2006, representing a decrease of 7% and increase of 11%, respectively. Commercial banking fees for the three-month period ended September 30, 2007 include lower of cost or market adjustments of $6.2 million on our commercial and industrial loan syndication held for sale portfolio. This loss was due to widening credit spreads in the market place due to decreased liquidity in the market place during the third quarter and was not due to the underlying credit quality of the specific loans held by Sovereign in this portfolio.

Net mortgage banking income was composed of the following components (in thousands):

Three months ended Nine months ended
September 30, September 30,
2007 2006 2007 2006
Mortgage servicing fees $ 10,504 $ 8,923 $ 30,693 $ 21,641
Amortization of mortgage servicing rights (9,532 ) (5,165 ) (27,250 ) (13,868 )
Net gains/(loss) under SFAS 133 1,781 (423 ) 2,176 4
Recoveries of/(Impairments to) mortgage servicing rights — (3,671 ) 656 (3,495 )
Net gain/(loss) recorded on commercial mortgage backed securitization (5,355 ) — 5,141 —
Sales of mortgage loans and related securities, home equity and multifamily loans 6,354 14,665 (88,369 ) 27,563

Total mortgage banking income $ 3,752 $ 14,329 $ (76,953 ) $ 31,845


	Three months ended						Six months ended
	June 30,						June 30,
	2008			2007			2008			2007
Sales of mortgage loans and related securities	$	4,999		$	3,317		$	8,977		$	8,864
Sale of correspondent home equity loans		—			—			—			(119,892	)
Net gains under SFAS 133		1,602			783			2,972			395
Mortgage servicing fees		12,182			10,460			24,098			20,189
Amortization of mortgage servicing rights		(11,034	)		(8,236	)		(19,103	)		(17,718	)
Residential mortgage servicing rights recoveries		19,837			656			1,134			656
Sales of multi-family loans		9,676			5,748			18,906			16,305
Recoveries/(impairments) to multi-family mortgage servicing rights		635			—			(4,220	)		—
Net gain recorded on commercial mortgage backed securitization		—			13,772			—			10,496


Total mortgage banking income	$	37,897		$	26,500		$	32,764		$	(80,705	)

Mortgage banking ~~results consist~~income consists of fees associated with servicing loans not held by Sovereign, as well as amortization and changes in the fair value of mortgage servicing rights. Mortgage banking results also include gains or losses on the sales of mortgage, home equity loans and lines of credit and ~~multifamily~~multi-family loans and mortgage-backed securities that were related to loans originated or purchased and held by Sovereign, as well as gains or losses on mortgage banking derivative and hedging transactions. Mortgage banking derivative instruments include principally interest rate lock commitments and forward sale commitments.

In the ~~third~~second quarter of ~~2007,~~2008, Sovereign recorded ~~lower~~gains on the sale of ~~cost or market adjustments~~multi-family loans of ~~$5.4~~$9.7 million on ~~its commercial real estate and multifamily held~~$885.9 million of multi-family loans compared to gains of $5.7 million on the sale of $503.4 million of loans for ~~sale portfolio. This loss was due to a widening of credit spreads~~the corresponding period in the ~~market place due to decreased liquidity in the market place and not due to the underlying credit quality of specific loans held by Sovereign in this portfolio.~~prior year. In the second quarter of ~~2007,~~2008, Sovereign ~~securitized $687.7~~recorded gains on the sale of mortgage loans of $5.0 million ~~and $327.0~~on $1.1 billion of mortgage loans compared to gains of $3.3 million on $592.1 million of ~~multi-family and commercial real estate~~ loans ~~respectively. As discussed~~for the corresponding period in Note 12, Sovereign retained certain subordinated certificates in this transaction. In connection with the $1.0 billion securitization, Sovereign recorded a gain of $13.8 million, which was included in mortgage banking revenues. This gain was determined based on the carrying amount of the loans sold, including any related allowance for loan loss, and was allocated to the loans sold and the retained interests, based on their relative fair values at the sale date. In the first quarter of 2007, Sovereign sold $1.3 billion of multi-family loans and recorded a gain of $6.1 million in connection with the sale. Mortgage banking revenues declined from the prior ~~year due to the previously discussed $119.9 million charge on the correspondent home equity portfolio.~~

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~year.

At ~~September~~June 30, ~~2007,~~2008, Sovereign serviced approximately ~~$10.3~~$12.9 billion of residential mortgage loans for others and our net mortgage servicing asset was ~~$132.5~~$161.7 million, compared to ~~$9.2~~$11.2 billion of loans serviced for others and a net mortgage servicing asset of ~~$118.6~~$141.1 million, at December 31, ~~2006.~~2007. The most important assumptions in the valuation of mortgage servicing rights are anticipated loan prepayment rates (CPR speed) and the positive spread we receive on holding escrow related balances. Increases in prepayment speeds (which are generally driven by lower long term interest rates) result in lower valuations of mortgage servicing rights, while lower prepayment speeds result in higher valuations. The escrow related credit spread is the estimated reinvestment yield earned on the serviced loan escrow deposits. Increases in escrow related credit spreads result in higher valuations of mortgage servicing rights while lower spreads result in lower valuations. For each of these items, Sovereign must make market assumptions based on future expectations. All of the assumptions are based on standards that we believe would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources. Additionally, an independent appraisal of the fair value of our mortgage servicing rights is obtained at least annually and is used by management to evaluate the reasonableness of our discounted cash flow model. For the three-month period ended ~~September~~June 30, ~~2006,~~2008, Sovereign recorded a $19.8 million of mortgage servicing right recovery due to a decrease in prepayment speed assumptions at June 30, 2008 compared to March 31, 2008 as shown below. This recovery was essentially a reversal of the $18.7 million residential mortgage servicing right impairment charge ~~of $3.5 million~~that we recorded in the three-month period ended March 31, 2008 due to ~~an increase in~~increased market based prepayment speed assumptions at ~~September 30, 2006~~March 31, 2008 compared to ~~June 30, 2006.~~December 31, 2007. Future changes to prepayment speeds may cause significant future charges or recoveries of previous impairments in future periods.

Listed below are the most significant assumptions that were utilized by Sovereign in its evaluation of mortgage servicing rights for the periods presented.


	September 30, 2007			December 31, 2006			September 30, 2006			June 30, 2008			March 31, 2008			December 31, 2007			June 30, 2007			March 31, 2007
CPR speed		12.77	%		14.23	%		12.50	%		12.19	%		20.64	%		14.70	%		11.43	%		14.81	%
Escrow credit spread		5.16	%		4.85	%		4.71	%		4.74	%		4.94	%		5.12	%		5.07	%		4.96	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Sovereign will periodically sell qualifying mortgage loans to FHLMC, GNMA, and FNMA ~~(“Fannie Mae”)~~ in return for mortgage-backed securities issued by those agencies. Sovereign reclassifies the net book balance of the loans sold to such agencies from loans to investment securities available for sale. For those loans sold to the agencies in which Sovereign retains servicing rights, Sovereign allocates the net book balance transferred between servicing rights and investment securities based on their relative fair values. If Sovereign sells the mortgage-backed securities which relate to underlying loans previously held by the Company, the gain or loss on the sale is recorded in mortgage banking income in the accompanying consolidated statement of operations. The gain or loss on the sale of all other mortgage-backed securities is recorded in gains on sales of investment securities on the consolidated statement of operations. During the second quarter of 2008, Sovereign sold $781 million of residential mortgage loans to FHLMC in return for mortgage-backed securities that were subsequently classified in our available for sale investment portfolio. Sovereign recorded a servicing asset of $8.4 million in connection with this transaction. At June 30, 2008, all of the investment securities have been retained on our balance sheet; therefore, this transaction did not have any impact on net income for the three-month or six-month periods ended June 30, 2008.

Sovereign originates and sells multi-family loans in the secondary market to Fannie Mae while retaining servicing. Generally, the Company can originate and sell loans to Fannie Mae for not more than $20.0 million per loan. Under the terms of the sales program with Fannie Mae, we retain a portion of the credit risk associated with such loans. As a result of this agreement with Fannie Mae, Sovereign retains a 100% first loss position on each multi-family loan sold to Fannie Mae under such program until the earlier to occur of (i) the aggregate losses on the ~~multifamily~~multi-family loans sold to Fannie Mae reaching the maximum loss exposure for the portfolio as a whole or (ii) until all of the loans sold to Fannie Mae under this program are fully paid off. The maximum loss exposure is available to satisfy any losses on loans sold in the program subject to the foregoing limitations.

The maximum loss exposure of the associated credit risk related to the loans sold to Fannie Mae under this program is calculated pursuant to a review of each loan sold to Fannie Mae. A risk level is assigned to each such loan based upon the loan product, debt service coverage ratio and loan to value ratio of the loan. Each risk level has a corresponding sizing factor which, when applied to the original principal balance of the loan sold, equates to a recourse balance for the loan. The sizing factors are periodically reviewed by Fannie Mae based upon its ongoing review of loan performance and are subject to adjustment. The recourse balances for each of the loans are aggregated to create a maximum loss exposure for the entire portfolio at any given point in time. The Company’s maximum loss exposure for the entire portfolio of sold loans is periodically reviewed and, based upon factors such as amount, size, types of loans and loan performance, may be adjusted downward. Fannie Mae is restricted from increasing the maximum exposure on loans previously sold to it under this program as long as (i) the total borrower concentration (i.e., the total amount of loans extended to a particular borrower or a group of related borrowers) as applied to all mortgage loans delivered to Fannie Mae since the sales program began does not exceed 10% of the aggregate loans sold to Fannie Mae under the program and (ii) the average principal balance per loan of all mortgage loans delivered to Fannie Mae since the sales program began continues to be $4.0 million or less.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~

~~Although all of the loans serviced for Fannie Mae (both loans originated for sale and loans sold from portfolio) are currently fully performing, the~~ Company has established a liability ~~which represents~~related to the fair value of the retained credit ~~exposure.~~exposure for loans sold to Fannie Mae. This liability represents the amount that the Company estimates that it would have to pay a third party to assume the retained recourse obligation. The estimated liability represents the present value of the estimated losses that the portfolio is projected to incur based upon an industry-based default curve with a range of estimated losses. At ~~September~~June 30, 2008 and December 31, 2007, Sovereign had a ~~$21.9~~$24.2 million and $23.5 million liability related to the fair value of the retained credit exposure for loans sold to Fannie Mae under this sales program.

At ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, Sovereign serviced ~~$10.3~~$12.2 billion and ~~$8.0~~$10.9 billion ~~respectively,~~ of loans for Fannie Mae ~~that had been~~ sold to ~~Fannie Mae~~it pursuant to this program with a maximum potential loss exposure of ~~$196.7~~$234.3 million and ~~$152.3~~$206.8 million, respectively. As a result of ~~retaining~~this retained servicing on multi-family loans sold to Fannie Mae, the Company had ~~a $19.4~~loan servicing assets of $18.6 million and $20.4 million ~~loan servicing asset~~ at ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, respectively. During the six-month period ended June 30, 2008 and the corresponding period in the prior year, Sovereign recorded servicing asset amortization of ~~$4.6~~$5.2 million and ~~$7.7~~$3.1 million, ~~related~~respectively. Additionally, during the first half of 2008, Sovereign recorded a net servicing right asset impairment charge of $4.2 million from lower escrow rate reinvestment yield assumptions due to recent interest rate cuts by the ~~multi-family loans sold~~Federal Reserve.

Capital markets revenues increased to ~~Fannie Mae~~$7.2 million and $17.6 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007 and recognized servicing assets of $2.4~~2008, compared to $6.0 million and ~~$6.7~~$11.7 million ~~respectively, during~~for the same ~~periods.~~

During the third quarter of 2007, Sovereign recorded charges of $19.4 million within capital markets revenue related to losses on repurchase agreements and market value contracts that Sovereign provided to a number of mortgage companies who declared bankruptcy and/or defaulted on their agreements. These mortgage companies have been impacted by adverse developmentsperiods in ~~the non-prime sector. Included in these charges was a write down of $4.8 million on $292 million of repurchase agreements to mortgage companies that are scheduled to mature in December~~ 2007. The ~~repurchase agreements are secured by rated and non-rated investment securities and/or mortgage loans. The charge Sovereign recorded~~reason for this increase was due to the declining interest rate environment in the third quarter was necessary since the value of the underlying collateral was less than the outstanding amount of the repurchase agreement. The realization of the amounts due under the repurchase agreements is dependant on the value of the underlying collateral. Although we believe that the repurchase agreements have been valued based on current conditions, future market value changes may impact2008 which has allowed us to sell more interest rate derivative products to our ~~results in the fourth quarter of 2007 if the collateral is liquidated and sold for less than our fair value estimates.~~customers.

Bank owned life insurance (BOLI) income represents the increase in the cash surrender value of life insurance policies for certain employees where the Bank is the beneficiary of the policies, as well as the receipt of insurance proceeds. The ~~increase~~decrease in BOLI income to ~~$24.4~~$19.1 million and ~~$65.2~~$38.5 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007, respectively,~~2008, compared to ~~$20.1~~$20.3 million and ~~$46.8~~$40.8 million for the comparable periods in the prior year is primarily due to ~~BOLI acquired in our acquisition of Independence and increased~~decreased death benefits in 2008.

Net gains on sales of investment securities were $1.9 million and $16.0 million for the three-month and six-month periods ended June 30, 2008, compared to $0 and $1.0 million for the same periods in 2007. In the first quarter of 2008, we recorded net cash proceeds of $14.1 million on the mandatory redemption of approximately half of our Visa Initial Public Offering (IPO) shares. Our remaining 522,718 Visa shares are required to be held for 3 years pending settlement of other possible litigation that Visa and its member banks are exposed to. These shares are required to be valued at their historical cost of $0. In March 2011, we will no longer have any restrictions on these shares.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

General and Administrative Expenses

General and administrative expenses for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007~~2008 were ~~$341.6~~$381.9 million and ~~$1.0 billion, respectively,~~$741.1 million, compared to ~~$351.8~~$336.6 million and ~~$935.1~~$666.6 million for the same periods in ~~2006.~~2007. General and administrative expenses ~~increased~~ for the ~~nine-month period~~three-month and six-month periods ended ~~September~~June 30, ~~2007 primarily~~2008 were impacted by increased deposit insurance premiums and an increase in compensation costs due to ~~increased compensation~~severance charges of $5.3 million and ~~benefit costs~~$6.4 million for the three-month and six-month periods ended June 30, 2008, respectively, associated with the ~~Independence acquisition. Average full time equivalents during~~departure of various senior executives as well as annual merit increases effective April 1, 2008. Higher deposit premium assessment rates were established in 2007 by the ~~third~~FDIC; however, Sovereign received a $29 million credit to be applied against future assessments, which was exhausted in the fourth quarter of ~~2007 declined to 11,344 from 11,793 due to~~2007. As a result, we incurred higher deposit premiums of $15.4 million in the ~~company’s cost savings initiatives. The decline in general and administrative costs for the three-month~~six-month period ~~ended September 30, 2007 as~~of 2008 compared to the corresponding period in the prior ~~year~~year. As previously discussed, Sovereign received proceeds from the mandatory redemption of our Visa IPO shares. This amount was net of proceeds Visa funded to an escrow account to provide for possible costs associated with pending litigation against Visa and its member banks. This funding allowed member banks of Visa to reverse litigation related accruals made in 2007. Sovereign had accrued $7.8 million in 2007 for this exposure and reversed $6.4 million of this amount in the three-month period ended March 31, 2008.

In July 2008, IndyMac Bank, F.S.B. (“IndyMac Bank”) was closed by the Office of Thrift Supervision (“OTS”) and the Federal Deposit Insurance Corporation (“FDIC”) was appointed as receiver of IndyMac Bank. As of March 31, 2008, IndyMac Bank was a $32.3 billion financial institution which had $18.9 billion in deposits and is ~~primarily~~the third largest bank failure in the history of the U.S. banking system. It is estimated that this failure will cost the FDIC deposit assessment fund between $4 billion and $8 billion. The FDIC charges financial institutions deposit premium assessments to ensure it has reserves to cover deposits that are under FDIC insured limits (generally $100,000 per depositor and $250,000 for retirement accounts). The FDIC Board of Directors has established a reserve ratio target percentage of 1.25%. This means that their “target” balance for the reserves is 1.25% of estimated insured deposits. As of March 31, 2008, the fund was $52.8 billion and insured deposits were $4.4 trillion, which resulted in a reserve ratio of 1.19% or 0.06 basis points below the FDIC Board’s target. If the fund falls below 1.15% of estimated insured deposits, the FDIC is required by law to adopt a restoration plan that will bring the reserve ratio back to 1.15% within five years. If the estimated loss to be incurred to the deposit assessment fund due to the IndyMac Bank failure is correct, it would reduce the reserve ratio percentage between 0.09% to 0.18% and result in the reserve ratio falling below 1.15% and require the adoption of a restoration plan which could entail increasing deposit premium assessment rates to all financial institutions. The timing and extent of any future increase is unknown at this time but could have an adverse impact ofon our ~~previously mentioned cost saving initiative.~~general and administrative expenses in future periods.

Other Expenses

Other expenses consist primarily of amortization of intangibles, minority interest expense, merger related and integration charges, equity method investment expense ~~employee severance~~ and other restructuring and proxy and related professional fees. Other expenses were ~~$44.0~~$42.8 million and ~~$240.2~~$80.3 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007,~~2008, compared to ~~$75.3~~$79.5 million and ~~$179.0~~$196.2 million for the same periods in ~~2006.~~2007. The reason for the variance is discussed below.

~~Total merger and integration~~Sovereign recorded charges of ~~$2.2~~$56.0 million and ~~$31.9~~$40.1 million for the ~~nine-month~~six-month period ended June 30, 2007 associated with restructuring charges and freezing its ESOP, respectively. Additionally, results for the three-month and six-month periods ended ~~September~~June 30, 2007 included $6.7 million and ~~2006,~~$12.9 million, respectively, ~~consisted primarily~~ of ~~charges~~expense related to an equity method investment Sovereign had in a synthetic fuel partnership that generated Section 29 tax credits for the ~~acquisition~~production of ~~Independence.~~fuel from a non-conventional source. We amortized this through December 31, 2007 since this was the period through which we received the tax credits. Therefore, we did not incur any expense nor did we record any tax credits in 2008 related to this investment.

Sovereign recorded intangible amortization expense of $28.1 million and $57.2 million for the three-month and six-month periods ended June 30, 2008, compared to $32.3 million and $65.5 million for the corresponding periods in the prior year. The decreases in the current year periods are due primarily to decreased core deposit intangible amortization expense on previous acquisitions.

4039

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Sovereign has an investment in a synthetic fuel partnership that generates IRC Section 29 tax credits for the production of fuel from a non-conventional source (“the Synthetic Fuel Partnership”). Our investment balance totaled $4.1 million at September 30, 2007. Sovereign is amortizing this investment through December 31, 2007, which is the period through which we expect to receive alternative energy tax credits. Reductions in the investment value and our allocation of the partnership’s earnings or losses totaled $6.9 million and $19.8 million for the three-month and nine-month periods ended September 30, 2007, respectively, and are included as expense in the line “Equity method investments” in our consolidated statement of operations, while the alternative energy tax credits we receive are included as a reduction of income tax expense. We anticipate receiving tax credits in excess of our recorded investment over the remaining life of the partnership. The alternative energy tax credit is reduced and ultimately eliminated based on a formula tied to the annual average wellhead price per barrel of domestic crude oil which is not subject to regulation by the United States.

As previously discussed, Sovereign recorded charges of $47.3 million and $40.1 million for the nine-month period ended September 30, 2007 associated with restructuring charges and freezing its ESOP, respectively. Sovereign also recorded debt extinguishment charges of $0.9 million and $14.7 million during the three-month and nine-month periods ended September 30, 2007, respectively.

Sovereign recorded intangible amortization expense of $31.1 million and $96.6 million for the three-month and nine-month periods ended September 30, 2007, respectively, compared to $34.1 million and $75.5 million for the corresponding periods in the prior year. The increase in the nine-month period is due primarily to the additional intangible amortization expense associated with core deposit and other intangible assets of $394.2 million recorded in connection with the Independence acquisition.

Income Tax Provision

An income tax ~~provision/(benefit)~~provision of ~~$(6.3)~~$29.1 million and ~~$16.7~~$51.2 million was recorded for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007, respectively,~~2008, compared to ~~$36.6~~$29.2 million and ~~$7.8~~$23.1 million for the same periods in ~~2006.~~2007. The effective tax rate for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007~~2008 was ~~(12.2)%~~18.6% and ~~6.2%~~18.4%, respectively, compared to ~~16.6%~~16.5% and ~~2.9%~~10.6% for the same periods in ~~2006.~~2007. The income tax provision in the second quarter of 2008 includes a $10.4 million provision to increase our reserves for income taxes based on recent rulings in certain states. The effective tax rate differs from the statutory rate of 35% primarily due to income from tax-exempt investments, income related to bank-owned life insurance, and tax credits associated with low income housing investment ~~partnerships and the Synthetic Fuel Partnership.~~partnerships. The lower effective tax rate for the ~~three-month and nine-month periods~~six-month period ended ~~September~~June 30, 2007 results from the ~~reduced level~~lower amount of pre-tax income of the Company for ~~those~~that time ~~periods. The effective tax rate for~~period. Additionally, as discussed above, the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2006 were impacted by~~2008 did not have any tax credits associated with the ~~tax benefit recorded on the $238.3 million loss on our investment restructuring and the $67.5 million other-than-temporary charge on FNMA/FHLMC preferred stock.~~synthetic fuel partnership.

Sovereign is subject to the income tax laws of the ~~U.S.,~~United States, its states and municipalities as well as certain foreign countries. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant Governmental taxing authorities. In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of these inherently complex tax laws.

Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. Sovereign reviews its tax balances quarterly and as new information becomes available, the balances are adjusted, as appropriate. The Company is subject to ongoing tax examinations and assessments in various jurisdictions. The Internal Revenue Service (the “IRS”) is currently examining the Company’s federal income tax returns for the years 2002 through 2005. ~~We anticipate~~The Company anticipates that the IRS will complete this review in the second half of 2008. Included in this examination cycle are two separate financing transactions with an international bank totaling $1.2 billion, which are discussed in Note 12 in the Company’s Form 10-K. As a result of these transactions, Sovereign was subject to foreign taxes ~~totaling~~of $154.0 million ~~dollars~~ during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and ~~for the nine-month period ended September 30,~~ 2007, Sovereign ~~accrued~~was subject to an additional $87.6 million and ~~$21.9~~$22.5 million, respectively, of foreign taxes ~~from this~~related to these financing ~~transaction~~transactions and claimed a corresponding foreign tax credit. ItWhile the IRS audit is ~~possible~~not complete, recent developments in our IRS audit leads us to expect that the IRS ~~may challenge~~will propose to disallow the ~~Company’s ability to claim these~~ foreign tax credits taken in 2003-2005 in the amount of $154.0 million related to these transactions and ~~could disallow the credits and~~to assess interest and potential penalties, ~~related~~the combined amount of which totaled approximately $73.4 million as of June 30, 2008. In addition, while the IRS has not yet initiated an audit for the years 2006 and 2007, we expect that in the future the IRS will propose to disallow the foreign tax credits taken in 2006 and 2007 of $87.6 million and $22.5 million, respectively, and to assess interest and potential penalties, the combined amount of which totals approximately $16.9 million as of June 30, 2008. Sovereign may need to litigate this ~~transaction.~~matter with the IRS. Sovereign believes that it is entitled to claim these foreign tax credits and also believes that its recorded tax reserves for this position of ~~$56.1~~$58.7 million adequately provides for any potential exposure to the IRS related to foreign tax credits and other tax assessments. However, as the ~~completion of~~Company continues to go through the IRS ~~review~~administrative process, and ~~their conclusion on Sovereign’s~~if necessary litigation, we will continue to evaluate the appropriate tax ~~positions included in the tax returns~~reserve levels for ~~2002 through 2005 could result in an adjustment~~this position and any changes made to the tax ~~balances and~~ reserves ~~that have been recorded and~~ may materially affect ~~our~~Sovereign’s income tax provision, net income and regulatory capital in future periods.

4140

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Line of Business Results

Segment results are derived from the Company’s business unit profitability reporting system by specifically attributing managed balance sheet assets, deposits and other liabilities and their related interest income or expense to each of our segments. Funds transfer pricing methodologies are utilized to allocate a cost for funds used or a credit for funds provided to business line deposits, loans and selected other assets using a matched funding concept. The provision for credit losses recorded by each segment is based on the net charge-offs of each line of business and the difference between the provision for credit losses recognized by the Company on a consolidated basis and the provision recorded by the business line at the time of charge-off is allocated to each business line based on the risk profile of their loan portfolio. Other income and expenses directly managed by each business line, including fees, service charges, salaries and benefits, and other direct expenses as well as certain allocated corporate expenses are accounted for within each segment’s financial results. Where practical, the results are adjusted to present consistent methodologies for the segments. Accounting policies for the lines of business are the same as those used in preparation of the consolidated financial statements with respect to activities specifically attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and benefits, expenses and other financial elements to each line of business.

During the first quarter of 2008, as previously discussed in our 2008 first quarter Form 10-Q, certain changes to our executive management were announced such as the hiring of a new head of Retail Banking and a new Chief Financial Officer. In addition, we centralized the responsibility for the major businesses within the Company naming a new head of Retail, Commercial Lending, Corporate Specialty Businesses and Corporate Support Services. The ~~Mid-Atlantic~~head of these business units report directly to the Chief Executive Officer and, along with our Chief Financial Officer and Chief Risk Officer, comprise the Executive Management Group. These events changed how our executive management team measures and assesses business performance. During the second quarter we finalized the process of updating our business unit profitability system to reflect our new organizational structure.

As a result of the changes discussed above, Sovereign now has four reportable segments. The Company’s segments are focused principally around the customers Sovereign serves. The Retail Banking Division is primarily comprised of our branch locations. Our branches offer a wide range of products and services to customers and each attracts deposits by offering a variety of deposit instruments including demand and NOW accounts, money market and savings accounts, certificates of deposits and retirement savings plans. Our branches also offer certain consumer loans such as home equity loans and other consumer loan products. The Corporate Specialties Group segment is primarily comprised of our mortgage banking group, our New York multi-family and national commercial real estate lending group, our automobile dealer floor plan lending group and our indirect automobile lending group. It also provides capital market services and cash management services to our customers. The Commercial Lending segment provides the majority of Sovereign’s commercial lending platforms such as commercial real estate loans, commercial industrial loans, leases to commercial customers and small business loans. The Other segment includes earnings from the investment portfolio, interest expense on Sovereign’s borrowings and other debt obligations, minority interest expense, amortization of intangible assets and certain unallocated corporate income and expenses.

The Retail Banking Division’s net interest income decreased ~~$2.1~~$46.1 million and ~~$9.5~~$107.2 million to ~~$77.8~~$264.9 million and ~~$230.6~~$514.6 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007~~2008 compared to the corresponding ~~periods~~period in the preceding year. The decrease in net interest income was due to margin compression on a matched funded ~~basis.~~basis due to the recent Federal Reserve interest rate cuts which have reduced the spreads that our Retail Banking Division receives on their deposits. The net spread on a match funded basis for this segment was ~~2.42%~~2.17% for the first ~~nine~~six months of ~~2007~~2008 compared to 2.55% for the same period in the prior year reflecting changes in the interest rate environment. The average balance of loans was $4.9 billion for the nine months ended September 30, 2007 compared to an average balance of $4.5 billion for the corresponding period in the preceding year. The average balance of deposits was $8.1 billion for the nine months ended September 30, 2007, compared to $8.3 billion for the same period a year ago. The provision for credit losses increased $2.8 million and $8.6 million for the three months and nine months ended September 30, 2007, respectively, and is driven by the charge-offs in the division’s loan portfolio. General and administrative expenses totaled $69.5 million and $209.7 million for the three months and nine months ended September 30, 2007, respectively, compared to $72.6 million and $212.0 million for the three months and nine months ended September 30, 2006. This decline is due to our previously mentioned expense savings initiative.

The New England Banking Division’s net interest income decreased $5.8 million and $21.6 million to $160.1 million and $475.2 million for the three-month and nine-month periods ended September 30, 2007, respectively, compared to the corresponding periods in the preceding year. The decrease in net interest income was principally due to margin compression on a matched funded basis. The net spread on a match funded basis for this segment was 2.66% for the first nine months of 2007 compared to 2.91%2.70% for the same period in the prior year. The average balance of loans was $6.3 billion for the ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 compared to an average balance of ~~$5.7~~$5.5 billion for the corresponding period in the preceding year. The average balance of deposits was ~~$18.2~~$42.3 billion for the ~~nine~~six months ended ~~September~~June 30, ~~2007,~~2008, compared to ~~$17.7~~$42.0 billion for the same period a year ago. The provision for credit losses increased ~~$7.7~~$7.0 million and $9.7 million to $10.9 million and $19.6 million for the three-month and nine-month periods ended September 30, 2007. General and administrative expenses (including allocated corporate and direct support costs) decreased from $124.9 million and $370.5$16.8 million for the three months and ~~nine~~six months ended ~~September~~June 30, ~~2006, respectively, to $118.3~~2008, and is driven by the charge-offs in the division’s loan portfolio. General and administrative expenses totaled $266.6 million and ~~$353.8~~$533.3 million for the three months and ~~nine~~six months ended ~~September~~June 30, ~~2007 or a decrease of 5.3%~~2008, compared to $267.1 million and ~~4.5%, respectively. This decline is primarily due to our previously mentioned expense savings initiative.~~$528.6 million for the three months and six months ended June 30, 2007.

4241

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

The ~~Metro New York Banking Division’s~~Corporate Specialty Group segment net interest income ~~decreased $15.7~~increased $7.1 million and ~~increased $134.9~~decreased $27.9 million to ~~$138.6~~$106.3 million and ~~$434.5~~$210.8 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007, respectively,~~2008 compared to the corresponding periods in the preceding year. The ~~increase~~decrease from prior year in net interest income ~~for the nine-month period~~ was due a decrease in average loans due to the ~~acquisition~~sale of ~~Independence on June 1, 2006. The decline~~$3.4 billion of correspondent home equity loans and $2.9 billion of residential mortgage loans as part of the balance sheet restructuring executed in ~~net interest income for the three-month period ended September 30, 2007 was due to spread compression.~~early 2007. The net spread on a match funded basis for this segment was ~~2.11%~~1.38% for the first ~~nine~~six months of ~~2007~~2008 compared to 2.26% for the same period in the prior year reflecting the difficult interest rate environment. The average balance of loans was $12.0 billion for the nine months ended September 30, 2007 compared to an average balance of $7.4 billion for the corresponding period in the preceding year. The average balance of deposits was $16.2 billion for the nine months ended September 30, 2007, compared to $11.9 billion for the same period a year ago. Average balances are impacted by the acquisition of Independence on June 1, 2006. See Note 16 for the assets and liabilities acquired in connection with this acquisition. The decrease in fees and other income of $17.1 million for the three-month period ended September 30, 2007 compared to the corresponding period in the preceding year was primarily due to the previously mentioned lower of cost or market adjustment of $5.4 million on commercial real estate and multifamily held for sale portfolio. Additionally, the prior year had a gain of $6.5 million on the sale of $776 million of multi-family loans. The increase in fees and other income of $30.6 million for the nine-month period ended September 30, 2007 compared to the corresponding period in the preceding year was primarily due to the acquisition of Independence. The provision for credit losses increased $11.8 million and $5.0 million to $14.1 million and $24.7 million for the three-month and nine-month periods ended September 30, 2007. General and administrative expenses (including allocated corporate and direct support costs) increased from $104.8 million and $202.9 million for the three months and nine months ended September 30, 2006, to $110.3 million and $325.9 million for the three months and nine months ended September 30, 2007. The increase in general and administrative expenses is due to the acquisition of Independence.

The Shared Services Consumer segment net interest income decreased $11.7 million and $6.5 million to $72.5 million and $244.6 million for the three-month and nine-month periods ended September 30, 2007 compared to the corresponding periods in the preceding year. The net spread on a match funded basis for this segment was 1.53% for the first nine months of 2007 compared to 1.40%1.39% for the same period in the prior year. The increase in spreads is due to the impact of the sale of $3.4 billion of correspondent home equity loans at the end of the first quarter of 2007, as well as increased originations of higher yielding auto loans. The average balance of loans for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007~~2008 was ~~$22.9~~$29.5 billion compared with ~~$24.8~~$33.5 billion for the corresponding period in the prior year. Fees and other income ~~was a net loss of $87.0~~were $52.2 million and $59.5 million for the ~~nine-month period~~three-month and six-month periods ended ~~September~~June 30, ~~2007~~2008 compared to ~~income~~$47.9 million and a loss of ~~$30.0~~$44.4 million for the corresponding ~~period~~periods in the prior year. The ~~reason for the decline was the previously discussed~~prior year results included a charge of $119.9 million on the correspondent home equity loan portfolio. The provision for credit losses increased ~~$79.1~~$45.5 million and ~~$78.1~~$107.0 million to ~~$108.7~~$69.7 million and ~~$147.4~~$148.6 million at ~~September~~June 30, ~~2007~~2008 due to ~~the previously mentioned increased credit reserves for the correspondent home equity and~~a higher level of losses on our indirect auto portfolio ~~that were recorded in~~particularly related to out-of-market auto loans. Charge-offs on out-of-market auto loans increased to $51.6 million during the ~~three-month period ended September 30,~~first half of 2008 compared to $5.6 million during the first half of 2007. General and administrative expenses totaled ~~$30.3~~$44.2 million and ~~$82.2~~$87.2 million for the three months and ~~nine~~six months ended ~~September~~June 30, ~~2007,~~2008, compared to ~~$26.5~~$39.4 million and ~~$92.0~~$81.5 million for the three months and ~~nine~~six months ended ~~September~~June 30, 2006. The decline in expenses for the nine-month period ended September 30, 2007 is a result of the aforementioned closure of the correspondent home equity business and the impact of our expense savings initiatives.2007.

The ~~Shared Services~~ Commercial Lending segment net interest income increased ~~$6.9~~$21.0 million and ~~$25.0~~$48.7 million to ~~$66.7~~$128.8 million and ~~$194.1~~$255.8 million for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007~~2008 compared to the corresponding periods in the preceding year due to growth in our commercial loan ~~portfolios.~~portfolios due to our emphasis on this asset class and a de-emphasis on wholesale residential loans, investment securities and other lower yielding asset classes. The net spread on a match funded basis for this segment was ~~2.20%~~2.36% for the first ~~nine~~six months of ~~2007~~2008 compared to ~~2.40%~~2.25% for the same period in the prior ~~year reflecting the difficult interest rate environment. However, this spread compression was more than offset by earning asset growth.~~year. The average balance of loans for the ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 was ~~$12.0~~$22.3 billion compared with ~~$10.0~~$19.8 billion for the corresponding period in the prior year. The decrease in fees and other income of $23.7 million and $4.7 million for the three-month and nine-month periods ended September 30, 2007 compared to the corresponding periods in the preceding year was primarily due to the previously discussed charges of $19.4 million within capital markets revenue related to losses on repurchase agreements and market value contracts. The provision for credit losses increased ~~$16.1~~$28.5 million and ~~$39.7~~$46.3 million to ~~$20.0~~$48.6 million and ~~$49.1~~$89.6 million for the three months and ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 due to ~~the previously mentioned $19.6 million increase~~higher reserve allocations on certain segments within our commercial loan portfolio, particularly those related to the ~~provision in the third quarter due to deterioration in the credit quality of certain commercial loans.~~residential real estate industry. General and administrative expenses (including allocated corporate and direct support costs) were ~~$36.7~~$56.3 million and ~~$108.6~~$103.9 million for the three months and ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 compared with ~~$36.8~~$45.5 million and ~~$99.6~~$89.0 million for the corresponding periods in the prior year. The reason for the increase is due to ~~investments~~compensation and benefit cost increases needed to support the growth of this reporting segment.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~

The net loss before income taxes for Other ~~increased $7.8~~decreased $78.8 million and ~~decreased $181.6~~$224.2 million to a net loss of ~~$58.8~~$24.4 million and ~~$181.0~~$18.8 million for the three months and ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 compared to the corresponding periods in the preceding year. Results for the three and six months ended June 30, 2007 included charges of $56.0 million and $40.1 million related to freezing our ESOP plan and certain restructuring charges, respectively. Net interest ~~expense~~income increased ~~$6.7~~$70.7 million and ~~$58.9~~$133.4 million to ~~$58.8~~$6.1 million and ~~$181.0~~$7.2 million for the three months and ~~nine~~six months ended ~~September~~June 30, ~~2007~~2008 compared to the corresponding periods in the preceding year due primarily to ~~the cost of borrowings~~investment yields increasing 551 basis points while ~~investments only increased 44~~borrowings decreased 55 basis points for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007.~~2008. Average borrowings for the ~~nine-month~~six-month period ended ~~September~~June 30, 2008 and 2007 ~~and 2006~~ were ~~$22.4~~$23.1 billion and ~~$22.2~~$22.9 billion, respectively, with an average cost of ~~5.29%~~4.73% and ~~4.74%~~5.28%. Average investments for the ~~nine-month~~six-month period ended ~~September~~June 30, 2008 and 2007 ~~and 2006~~ was ~~$14.4~~$12.6 billion and ~~$14.3~~$14.6 billion respectively, at an average yield of ~~6.15%~~6.13% and ~~5.71%~~6.12%.

The Other segment includes the previously mentioned restructuring, severance and debt extinguishment charges of $62.0 million for the nine-months ended September 30, 2007 as well as $40.1 million expense related to freezing our ESOP plan. See Note 15 for further discussion. The nine-month period ended September 30, 2006 included proxy and related professional fee expense of $14.3 million which is also discussed in Note 15. The nine-month period ended September 30, 2006 included the previously mentioned pre-tax investment restructuring losses of $238.3 million on the sale of $3.5 billion of investments, the other-than-temporary impairment charge of $67.5 million of FNMA and FHLMC preferred stock and the loss on economic hedges of $11.4 million. See Note 3 for further discussion.

Critical Accounting Policies

The Company’s significant accounting policies are described in Note 1 to the December 31, ~~2006~~2007 consolidated financial statements filed on Form 10-K. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. We have identified accounting for the allowance for loan losses, securitizations, derivatives, income taxes and goodwill as our most critical accounting policies and estimates in that they are important to the portrayal of our financial condition and results, and they require management’s most difficult, subjective or complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout this Management’s Discussion and Analysis and the December 31, ~~2006~~2007 Management’s Discussion and Analysis filed on Form 10-K.

During 2007, Sovereign financial results were impacted by an increase in credit losses, slower than anticipated growth in low cost core deposits, and a continued unfavorable interest rate environment. Sovereign recorded a number of significant charges in 2007 as described herein which caused current year results to be less than our internal plan.

We did consider these events and whether they could be potential indicators of goodwill impairment. Although these events, as well as decreases in valuations for all banks, had an impact on the fair value of our segments, we believe that the fair value of our segments continues to be in excess of book value for our segments. In the fourth quarter, we will be performing our annual assessment of goodwill impairment using a third party valuation firm. We will continue to evaluate future performance and market conditions and consider any changes in these areas in our goodwill impairment valuation in future periods.

A discussion of the impact of new accounting standards issued by the FASB and other standard setters are included in Note 1215 to the consolidated financial statements.

4442

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

FINANCIAL CONDITION

Loan Portfolio

At ~~September~~June 30, ~~2007,~~2008, commercial loans totaled ~~$25.9~~$27.8 billion representing ~~45.3%~~48.4% of Sovereign’s loan portfolio, compared to ~~$24.7~~$26.7 billion or ~~39.5%~~46.2% of the loan portfolio at December 31, ~~2006~~2007 and ~~$24.0~~$25.5 billion or ~~38.0%~~45.2% of the loan portfolio at ~~September~~June 30, ~~2006.~~2007. At ~~September~~both June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, only 7% ~~and 6%, respectively,~~ of our total commercial portfolio was unsecured. The increase in commercial loans since December 31, ~~2006~~2007 has been driven by organic loan ~~growth, offset by the sale of $327 million of commercial real estate loans as part of the securitization in the second quarter.~~growth. The increase in commercial loans as a percentage of the total loan portfolio is consistent with management’s 2007 restructuring plan to deemphasize lower yielding residential ~~and multi-family loans and increase our commercial loan portfolio.~~loans.

At ~~September~~June 30, ~~2007,~~2008, multi-family loans totaled ~~$4.0~~$4.7 billion representing ~~7.1%~~8.1% of Sovereign’s loan portfolio, compared to ~~$5.8~~$4.2 billion or ~~9.2%~~7.3% of the loan portfolio at December 31, ~~2006~~2007 and ~~$6.0~~$4.0 billion or ~~9.5%~~7.1% of the loan portfolio at ~~September~~June 30, 2006. The decrease from the prior year is due to initiative to reduce the percentage of this asset class that is held on balance sheet and increase the amount that can be sold to Fannie Mae or the secondary markets. In the second quarter of 2007, Sovereign sold $687.7 million of this loan portfolio as part of the commercial mortgage backed securitization. In the first quarter of 2007, Sovereign sold $1.3 billion of this loan portfolio as part of the Company’s previously discussed balance sheet restructuring plan.2007.

The consumer loan portfolio secured by real estate (consisting of home equity loans and lines of credit of ~~$6.1~~$6.5 billion and residential loans of ~~$14.0~~$11.9 billion) totaled ~~$20.1~~$18.4 billion at ~~September~~June 30, ~~2007,~~2008, representing ~~35.1%~~32.0% of Sovereign’s loan portfolio, compared to ~~$26.8~~$19.5 billion, or ~~42.9%~~33.8%, of the loan portfolio at December 31, ~~2006~~2007 and ~~$28.3~~$20.3 billion or ~~44.8%~~36.0% of the loan portfolio at ~~September~~June 30, 2006. The decrease in the consumer loan portfolio secured by real estate was driven by the sale of $3.4 billion of correspondent home equity loans and $2.9 billion of residential loans that occurred during the first quarter in connection with the balance sheet restructuring.2007.

The consumer loan portfolio not secured by real estate (consisting of ~~indirect~~ automobile loans of ~~$6.9~~$6.3 billion and other consumer loans of ~~$0.3~~$302.8 million) totaled ~~$7.2~~$6.6 billion at ~~September~~June 30, ~~2007,~~2008, representing ~~12.5%~~11.5% of Sovereign’s loan portfolio, compared to ~~$5.3~~$7.3 billion, or ~~8.4%~~12.7%, of the loan portfolio at December 31, ~~2006~~2007 and ~~$4.8~~$6.6 billion or ~~7.7%~~11.7% of the loan portfolio at ~~September~~June 30, ~~2006.~~2007. The ~~increase~~decrease in the consumer loan portfolio not secured by real estate from prior quarter is primarily due to ~~organic~~the cessation of out-of-market auto lending on January 31, 2008. Additionally, the Company has tightened its underwriting standards on its in-market ~~growth and a decision in mid-2006 to expand~~auto loans portfolio which slowed originations. Second quarter 2008 auto loan ~~production offices~~originations within our geographic footprint totaled $239 million compared with $503 million in the Southeastern and Southwestern United States. The Southwest and Southeast production offices have significantly contributed to the growth in auto loan balances; and these loan portfolios are approximately 35%first quarter of ~~our outstanding auto loan portfolio and approximately 61% of our year to date 2007 auto loan originations. However, as~~2008. As previously discussed, ~~losses from the Southeastern~~effective January 31, 2008, management ceased originating out-of-market auto loans.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and ~~Southwestern production offices have been higher than anticipated. The Company has taken several steps to reduce the loss rates from these offices~~Analysis of Financial Condition and ~~increase the overall profitability~~Results of these loans such as strengthening underwriting standards and eliminating business with dealers prone to default. These steps are anticipated to curb the recent growth rates from loans generated by the Southeast and Southwest production offices.Operations (continued)

Non-Performing Assets

At ~~September~~June 30, ~~2007,~~2008, Sovereign’s non-performing assets increased by ~~$101.1~~$192.3 million to ~~$336.7~~$553.9 million compared to ~~$235.6~~$361.6 million at December 31, ~~2006.~~2007. This increase is ~~due~~ primarily related to residential mortgages, ~~and home equity~~commercial real estate loans, multi-family loans and ~~lines of credit.~~commercial and industrial loans. Non-performing assets as a percentage of total loans, real estate owned and repossessed assets ~~weakened~~increased to ~~0.59%~~0.96% at ~~September~~June 30, ~~2007~~2008 from ~~0.43%~~0.63% at December 31, ~~2006.~~2007. In response to these increases, Sovereign increased its reserves for credit losses on our loan portfolio to $843.5 million or 1.47% of total loans at June 30, 2008 from $737.7 million or 1.28% at December 31, 2007. Sovereign generally places all commercial loans on non-performing status at 90 days delinquent or sooner, if management believes the loan has become impaired (unless return to current status is expected imminently). All other consumer and residential loans continue to accrue interest until they are 120 days delinquent, at which point they are either charged-off or placed on non-accrual status and anticipated losses are reserved for. Loans secured by residential real estate with loan to values of 50% or less, based on current valuations, are considered well secured and in the process of collection and therefore continue to accrue interest. At 180 days delinquent, anticipated losses on residential real estate loans are fully reserved for or charged off.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~

The following table presents the composition of non-performing assets at the dates indicated (amounts in thousands):


	September 30,			December 31,			June 30,			December 31,
	2007			2006			2008			2007
Non-accrual loans:
Consumer:
Residential mortgages	$	79,909		$	47,687		$	133,114		$	90,881
Home equity loans and lines of credit⁽²⁾		53,974			10,312			65,213			56,099
Auto loans and other consumer loans		2,806			2,955			2,750			3,446

Total consumer loans		136,689			60,954			201,077			150,426
Commercial		78,251			69,207			129,693			85,406
Commercial real estate		65,226			75,710			117,251			61,750
Multifamily		1,751			1,486
Multi-family								42,230			6,336


Total non-accrual loans		281,917			207,357			490,251			303,918
Restructured loans		443			557			280			370


Total non-performing loans⁽²⁾		282,360			207,914			490,531			304,288

Other real estate owned		43,517			22,562			48,228			43,226
Other repossessed assets		10,861			5,126			15,168			14,062


Total other real estate owned and other repossessed assets		54,378			27,688			63,396			57,288


Total non-performing assets⁽²⁾	$	336,738		$	235,602		$	553,927		$	361,576


Past due 90 days or more as to interest or principal and accruing interest	$	64,816		$	40,103		$	73,694		$	68,770
Annualized net loan charge-offs to average loans⁽³⁾		.19	%		.96	%		.55	%		.25	%
Non-performing assets as a percentage of total assets^{(2) (4)}		.39	%		.29	%
Non-performing loans as a percentage of total loans^{(2) (4)}		.49	%		.38	%
Non-performing assets as a percentage of total loans and real estate owned^{(2) (4)}		.59	%		.43	%
Allowance for credit losses as a percentage of total non-performing assets^{(2) (1)}		193.0	%		206.4	%
Allowance for credit losses as a percentage of total non-performing loans^{(2) (1)}		230.2	%		233.9	%
Non-performing assets as a percentage of total assets								.70	%		.43	%
Non-performing loans as a percentage of total loans								.85	%		.53	%
Non-performing assets as a percentage of total loans, real estate owned and repossessed assets								.96	%		.63	%
Allowance for credit losses as a percentage of total non-performing assets⁽¹⁾								152.3	%		204.0	%
Allowance for credit losses as a percentage of total non-performing loans⁽¹⁾								172.0	%		242.4	%

~~These risk factors are continuously reviewed~~

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and ~~revised by management where conditions indicate that the estimates initially applied are different from actual results. A comprehensive analysis~~Analysis of ~~the allowance for loan losses~~Financial Condition and ~~reserve for unfunded lending commitments is performed by the Company on a quarterly basis. In addition, a review~~Results of ~~allowance levels based on nationally published statistics is conducted on at least an annual basis.~~Operations (continued)

In addition to the Allowance for Loan Losses, we also estimate probable losses related to unfunded lending commitments. Unfunded lending commitments are subject to individual reviews, and are analyzed and segregated by risk according to the Corporation’s internal risk rating scale. These risk classifications, in conjunction with an analysis of historical loss experience, current economic conditions and performance trends within specific portfolio segments, and any other pertinent information result in the estimation of the reserve for unfunded lending commitments. Additions to the reserve for unfunded lending commitments are made by charges to the provision for credit losses.

These risk factors are continuously reviewed and revised by management where conditions indicate that the estimates initially applied are different from actual results. A comprehensive analysis of the allowance for loan losses and reserve for unfunded lending commitments is performed by the Company on a quarterly basis. In addition, a review of allowance levels based on nationally published statistics is conducted on at least an annual basis.

The factors supporting the allowance for loan losses and the reserve for unfunded lending commitments do not diminish the fact that the entire allowance for loan losses and the reserve for unfunded lending commitments are available to absorb losses in the loan portfolio and related commitment portfolio, respectively. The Company’s principal focus, therefore, is on the adequacy of the total allowance for loan losses and reserve for unfunded lending commitments.

The allowance for loan losses and the reserve for unfunded lending commitments are subject to review by banking regulators. The Company’s primary bank regulators regularly conduct examinations of the allowance for loan losses and reserve for unfunded lending commitments and make assessments regarding their adequacy and the methodology employed in their determination.

Commercial Portfolio. The portion of the allowance for loan losses related to the commercial portfolio has increased from ~~$375.0~~$434.0 million at December 31, ~~2006~~2007 (1.40% of commercial loans) to ~~$418.7~~$527.6 million at ~~September~~June 30, ~~2007.~~2008 (1.63% of commercial loans). This is a result of an increase in non-performing assets and other criticized assets at ~~September~~June 30, ~~2007~~2008 and loan growth which required additional reserves. ~~As a percentage~~Additionally, Sovereign increased its reserve allocations in the first quarter of 2008 in anticipation of continued deteriorating in these loan portfolios in the near term. A large portion of this increase was related to loans to companies that are in housing related industries. We expect that the difficult housing environment as well as economic conditions will continue to impact our commercial loans, the allowance increased from 1.24% to 1.41% at September 30, 2007 which reflects the continued weakening of the commercial loan portfolio in 2007 compared to the prior year, primarily in construction lending and commercial real estate portfolios which may result in increased reserve allocations and ~~commercial industrial lending.~~higher provisions for loan losses in future periods.

Consumer Secured by Real Estate Portfolio. The allowance for the consumer loans secured by real estate portfolio increased to ~~$105.3~~$131.9 million at ~~September~~June 30, ~~2007~~2008 from ~~$45.5~~$117.4 million at December 31, ~~2006.~~2007. The increase is primarily the result of ~~the previously mentioned $47 million increase~~increased reserves allocated to our ~~reserves~~residential loan portfolio due to ~~credit deterioration on the second lien~~continued weaknesses in residential real estate prices. Non-performing assets and past due loans for our residential portfolios, particularly in our $2.8 billion Alt-A portfolio, ~~of the correspondent home equity loan portfolio that was not sold.~~continue to increase. As a percentage of consumer loans secured by real estate the allowance was ~~0.53%~~0.72% at ~~September~~June 30, ~~2007~~2008 compared with ~~0.23%~~0.60% at December 31, ~~2006.~~2007. We expect that the difficult housing environment as well as general economic conditions will continue to impact our residential portfolio which may result in higher loss levels. In response, during the first and second quarters of 2008, we increased the reserve for consumer loans secured by real estate by $9.4 million and $8.3 million, respectively.

~~During the second quarter of 2006,~~ Sovereign entered into a credit default swap in 2006 on a portion of its residential real estate loan portfolio through a synthetic securitization structure. Under the terms of the credit default swap, Sovereign is responsible for the first $5.2 million of losses on the remaining ~~balance of~~ loans in the structure which totaled ~~$3.4~~$3.1 billion at ~~September~~June 30, ~~2007.~~2008. Sovereign is reimbursed tofor the next ~~$55.2~~$55 million of losses under the terms of the credit default swap. Losses ~~in excess of this amount would be~~above $60.2 million are borne by Sovereign. This credit default swap term is equal to the term of the loan portfolio. ~~The structure resulted in fewer reserves being allocated to the residential loan portfolio as a portion of the losses are reimbursed through the credit default swap.~~

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~

Consumer Not Secured by Real Estate Portfolio. The allowance for the consumer not secured by real estate portfolio ~~increased~~decreased from ~~$45.7~~$149.8 million at December 31, ~~2006~~2007 to ~~$98.7~~$140.8 million at ~~September~~June 30, ~~2007~~2008 primarily due to ~~an increase of $2.0 billion~~a decrease in auto ~~loans.~~loans of $722.4 million. This ~~growth has been~~decline was due ~~primarily~~ to our ~~efforts~~decision to ~~expand into certain markets~~stop originating out of market loans effective January 31, 2008 as well as a reduction in the ~~Southeast and Southwestern United States. Loan~~amount of auto loan originations in 2008 compared to 2007 origination levels within our geographic footprint, as we have strengthened our underwriting standards. In footprint auto loan originations for ~~these markets during~~ the ~~first nine months~~six-month period ended June 30, 2008 were $742 million compared to $1.1 billion for the corresponding period in the prior year. During 2007, Sovereign originated $2.8 billion of 2007 totaled $2.4 billion at a weighted average yield of 8.14%. However, as previously discussed, losses during the third quarter of 2007 on this portfolio have been higher than anticipated. This resulted in an increase to our reserve allocations for this portfolio to cover higher inherent losses on the portfolio. This caused a $37 million increase to ourout-of-market auto loans. The allowance for credit losses during the third quarter of 2007. Management strengthened its underwriting guidelines towards the end of the third quarter of 2007 for this portfolio which we believe will lower the loss experience on new originations. As a result of these events, the allowance for loan losses increased, and as a result the reserve as a percentage of consumer loans not secured by real estate ~~has increased from 0.87%~~was 2.13% at June 30, 2008 and 2.04% at December 31, ~~2006 to 1.38% at September 30,~~ 2007.

Unallocated Allowance. The unallocated allowance for loan losses ~~increased to $7.0~~was $8.5 million at ~~September~~June 30, ~~2007 from $4.8~~2008 and $8.3 million at ~~December��~~December 31, ~~2006.~~2007. Management continuously evaluates its class allowance reserving methodology; however the unallocated allowance is subject to changes each reporting period due to a level of imprecision in management’s estimation process.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Reserve for unfunded lending commitments. The reserve for unfunded lending commitments has increased from ~~$15.3~~$28.3 million at December 31, ~~2006~~2007 to ~~$20.3~~$34.8 million at ~~September~~June 30, ~~2007~~2008 due to ~~changes in the amounts of unfunded commitments during these time periods, as well as~~ increases in the amount of criticized ~~lines~~commercial loan commitments since ~~year end.~~year-end.

Investment Securities

Investment securities consist primarily of mortgage-backed securities, tax-free municipal securities, U.S. Treasury and government agency securities, corporate debt securities, collateralized debt obligations and stock in the Federal Home Loan Bank of Pittsburgh (“FHLB”), Freddie Mac and Fannie Mae. Mortgage-backed securities consist of pass-throughs and collateralized mortgage obligations issued by federal agencies or private label issuers. Sovereign’s mortgage-backed securities are generally either guaranteed as to principal and interest by the issuer or have ratings of “AAA” by Standard and Poor’s and Moody’s at the date of issuance. Sovereign purchases classes which are senior positions backed by subordinate classes. The subordinate classes absorb the losses and must be completely eliminated before any losses flow through the senior positions. The effective duration of the available for sale investment portfolio at ~~September~~June 30, ~~2007~~2008 was ~~4.1~~5.6 years.

Total investment securities available-for-sale were ~~$14.3~~$11.1 billion at ~~September~~June 30, ~~2007~~2008 and $13.9 billion at December 31, ~~2006.~~2007. For additional information with respect to Sovereign’s investment securities, see Note 3 in the Notes to Consolidated Financial Statements.

Sovereign holds preferred stock in Fannie Mae and Freddie Mac which has a cost basis of $622.6 million and an unrealized loss of $34.4 million at June 30, 2008. These losses are related to liquidity spreads due to negative events on the issuers of these securities. These securities have experienced significant changes in prices month-to-month based on movements in credit spreads and as recently as May 31, 2008, the securities were in a net unrealized gain position of $11.3 million. We perform an analysis of the individual securities each quarter and evaluate the prospects of the issuers when considering whether an other-than-temporary impairment exists. As of June 30, 2008, each of the individual securities was investment grade. Given the short duration of the losses and the fact that the losses were not severe, we concluded that the above unrealized losses are temporary in nature at June 30, 2008.

Other investments, which consists of FHLB stock and repurchase agreements, decreased ~~slightly~~ to ~~$982~~$944.6 million at ~~September~~June 30, ~~2007~~2008 from ~~$1.0~~$1.2 billion at December 31, ~~2006.~~2007 due to a reduction in FHLB stock as Sovereign reduced its amount of FHLB borrowings since year-end in connection with its plan to reduce wholesale borrowings.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Goodwill and Other Intangible Assets

Goodwill was ~~$5.0~~$3.4 billion at both ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006.~~2007. Other intangibles decreased by ~~$96.6~~$57.2 million at ~~September~~June 30, ~~2007~~2008 compared to December 31, ~~2006~~2007 due to year-to-date amortization expense.

The Company follows SFAS No. 142, “Goodwill and Other Intangible Assets,” to account for its goodwill. This statement provides that goodwill and other indefinite lived intangible assets will not be amortized on a recurring basis, but rather will be subject to periodic impairment testing. ~~Sovereign did not record any~~There were no goodwill or ~~other~~core deposit intangible asset impairment charges ~~in 2006 or~~recorded in the ~~nine~~six months ended ~~September~~June 30, 2008 or June 30, 2007.

During 2007 Sovereign’s financial results were negatively impacted by an increase in credit losses, slower than anticipated growth in low cost core deposits and a continued unfavorable interest rate environment. The market conditions and related concerns surrounding credit caused valuations for banking and other financial service companies to decrease significantly during the fourth quarter of 2007. The market price of our common stock decreased from a high of $25.16 during the second quarter of 2007 to a low of $10.08 in the fourth quarter of 2007, a 60% decrease. The significant drop in value caused our book value per common share to be significantly higher than our market stock price. Additionally, in response to the credit downturn in 2007, we tightened our underwriting standards and made strategic changes to our business, including exiting activities that were not within the Sovereign footprint.

During the fourth quarter of 2007, we completed our annual assessment of goodwill using a third party valuation firm who considered the impact of current credit conditions, the exiting of certain business activities, our 2007 actual results, expected results for 2008, as well as current market valuations. We evaluated goodwill for impairment ~~test~~ for ~~goodwill requires the Company~~each of our reporting units under 3 different valuation approaches (transaction market approach, guideline company approach, and discounted net income approach) to ~~compare~~ensure that the fair value of ~~its business~~our reporting units ~~to their carrying value~~was in excess of our net book values including the goodwill assigned to such unit. SFAS No. 142 requires Sovereign to review goodwill for potential impairment annually, or for interim periods if changes in circumstances or the occurrence of events indicate impairment potentially exists.goodwill. Based on ~~the significant charges Sovereign recorded during the three-month period ended September 30, 2007, Sovereign conducted an interim review~~this analysis, we concluded that we had a goodwill impairment charge of ~~its goodwill at September 30, 2007 and determined that no impairment existed.~~

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~$1.58 billion.

Determining the fair value of ~~Sovereign’s reporting units requires management to allocate assets~~each of our segments involves a significant amount of judgment, and ~~liabilities to such units~~the results are dependent on the Company attaining results consistent with the forecasts and to make judgments and assumptions with respect to a number of matters, including, among other things, discount rates, estimates of future operating results, and appropriate multiples for valuation purposes. Changes in any of these allocations or assumptions may result in different valuations and a different result with respect to impairment of one or more reporting units. However, management believes that the estimates or assumptions used in its valuation model. Assumptions such as growth, credit risk, interest rates, and expense expectations, have a significant impact on each segment’s overall fair value, and are all subject to change as market conditions worsen or improve. During the second quarter of 2008, we reorganized our reporting units and updated our impairment analysis based on these new segments. Although market conditions in 2008 have remained challenging and valuations for banking and other financial institutions have declined since year-end, we believe the fair value of our segments continues to be in excess of their book value. However, in response to a longer term credit down cycle, management may change the assumptions in the Company’s business plan which could have implications to the fair value derived from our valuation models.

In the fourth quarter of 2008, we will be performing our annual assessment of goodwill impairment ~~analysis for its current business units were reasonable. In conjunction~~ with ~~its annual~~the assistance of a third party valuation firm. We will continue to evaluate future performance and market conditions and will consider these developments in our goodwill impairment ~~review at December 31, 2007, Sovereign intends to engage an independent~~ valuation ~~expert to assist the Company~~ in ~~its analysis.~~future periods.

The estimated aggregate amortization expense related to core deposit intangibles for each of the five succeeding calendar years ending December 31 is (in thousands):


	Calendar				Remaining		Calendar				Remaining
	Year		Recorded		Amount		Year		Recorded		Amount
Year	Amount		To Date		To Record		Amount		To Date		To Record
2007	$	122,897	$	93,639	$	29,258
2008		100,467		—		100,467	$	100,467	$	55,540	$	44,927
2009		71,341		—		71,341		71,341		—		71,341
2010		56,617		—		56,617		56,617		—		56,617
2011		44,963		—		44,963		44,963		—		44,963
2012								33,108		—		33,108

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~

In certain transactions, Sovereign has transferred assets to SPEs qualifying for non-consolidation (“QSPE”) and has accounted for the transaction as a sale in accordance with SFAS No. 140. Sovereign also has interests that continue to be held in the QSPEs. Off-balance sheet QSPEs had ~~$2.0~~$1.9 billion of assets that Sovereign sold to the QSPEs which are not included in Sovereign’s Consolidated Balance Sheet at ~~September~~June 30, ~~2007.~~2008. Sovereign’s interests that continue to be held and servicing assets in such QSPEs was ~~$94.5~~$61.9 million at ~~September~~June 30, ~~2007~~2008 and this amount represents Sovereign’s maximum exposure to credit losses related to these unconsolidated securitizations. Sovereign does not provide contractual legal recourse to third party investors that purchase debt or equity securities issued by the QSPEs beyond the credit enhancement inherent in Sovereign’s subordinated interests in the QSPEs. At ~~September~~June 30, ~~2007,~~2008, there are no known events or uncertainties that would result in or are reasonably likely to result in the termination or material reduction in availability to Sovereign’s access to off-balance sheet markets. See Note 1210 for a description of Sovereign’s interests that continue to be held in its off-balance sheet asset securitizations.

Bank Regulatory Capital

The Financial Institutions Reform, Recovery and Enforcement Act (“FIRREA”) requires institutions regulated by the Office of Thrift Supervision (OTS) to have a minimum ~~leverage~~tangible capital ratio equal to 3%1.5% of tangible assets, and a minimum leverage ratio equal to 4% of ~~risk-adjusted~~tangible assets, and a risk-based capital ratio equal to 8% as defined. The Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) requires OTS regulated institutions to have minimum tangible capital equal to 2% of total tangible assets.

The FDICIA established five capital tiers: well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A depository institution’s capital tier depends upon its capital levels in relation to various relevant capital measures, which include leverage and risk-based capital measures and certain other factors. Depository institutions that are not classified as well-capitalized or adequately-capitalized are subject to various restrictions regarding capital distributions, payment of management fees, acceptance of brokered deposits and other operating activities. At ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, Sovereign Bank had met all quantitative thresholds necessary to be classified as well-capitalized under regulatory guidelines.

Federal banking laws, regulations and policies also limit Sovereign Bank’s ability to pay dividends and make other distributions to Sovereign Bancorp. Sovereign Bank is required to give prior notice to the OTS before paying any dividend. In addition, Sovereign Bank must obtain prior OTS approval to declare a dividend or make any other capital distribution if, after such dividend or distribution, Sovereign Bank’s total distributions to Sovereign within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years, or if Sovereign Bank is not adequately capitalized at the time. In addition, OTS prior approval would be required if Sovereign Bank’s examination or CRA ratings fall below certain levels or Sovereign Bank is notified by the OTS that it is a problem association or an association in troubled condition. The following schedule summarizes the actual capital balances of Sovereign Bank at ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006~~2007 (in thousands):


							TIER 1			TOTAL
				TIER 1			RISK-BASED			RISK-BASED
	TANGIBLE			LEVERAGE			CAPITAL TO			CAPITAL TO			TIER 1			TIER 1			TOTAL
	CAPITAL TO			CAPITAL TO			RISK			RISK			LEVERAGE			RISK-BASED			RISK-BASED
	TANGIBLE			TANGIBLE			ADJUSTED			ADJUSTED			CAPITAL			CAPITAL			CAPITAL
REGULATORY CAPITAL	ASSETS			ASSETS			ASSETS			ASSETS			RATIO			RATIO			RATIO
Sovereign Bank at September 30, 2007:
Sovereign Bank at June 30, 2008:
Regulatory capital	$	5,391,912		$	5,391,912		$	5,136,442		$	6,954,637		$	5,538,038		$	5,262,374		$	7,642,694
Minimum capital requirement (1)		1,626,791			3,253,582			2,681,869			5,363,738			3,041,782			2,678,158			5,356,315

Excess													$	2,496,256		$	2,584,216		$	2,286,379

Sovereign Bank capital ratio														7.28	%		7.86	%		11.41	%

Sovereign Bank at December 31, 2007:
Regulatory capital													$	5,289,889		$	5,030,620		$	6,939,602
Minimum capital requirement (1)														3,237,187			2,668,712			5,337,424

Excess	$	3,765,121		$	2,138,330		$	2,454,573		$	1,590,899		$	2,052,702		$	2,361,908		$	1,602,178


Sovereign Bank capital ratio		6.63	%		6.63	%		7.66	%		10.37	%		6.54	%		7.54	%		10.40	%

Sovereign Bank at December 31, 2006:
Regulatory capital	$	5,224,710		$	5,224,710		$	5,023,535		$	6,726,462
Minimum capital requirement (1)		1,679,397			3,358,794			2,671,247			5,342,494


Excess	$	3,545,313		$	1,865,916		$	2,352,288		$	1,383,968


Sovereign Bank capital ratio		6.22	%		6.22	%		7.52	%		10.07	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

Listed below are capital ratios for Sovereign Bancorp.

TANGIBLE
COMMON TANGIBLE TIER 1
EQUITY TO EQUITY TO LEVERAGE
TANGIBLE TANGIBLE CAPITAL
REGULATORY CAPITAL ASSETS ASSETS RATIO
Capital ratio at September 30, 2007 (1) 3.85 % 4.09 % 6.03 %
Capital ratio at December 31, 2006 (1) 3.50 % 3.73 % 5.73 %

TANGIBLE

COMMON

TANGIBLE

EQUITY TO

TANGIBLE

TIER 1

ASSETS

LEVERAGE

EXCLUDING

INCLUDING

EXCLUDING

INCLUDING

CAPITAL

REGULATORY CAPITAL

OCI₍₂₎

RATIO

Capital ratio at June 30, 2008₍₁₎

6.92

6.04

7.18

6.29

8.34

Capital ratio at December 31, 2007₍₁₎

4.43

4.04

4.67

4.28

5.89


(1)		OTS capital regulations do not apply to savings and loan holding companies. These ratios are computed as if those regulations did apply to Sovereign Bancorp, Inc.

(2)		Tangible equity and tangible assets are defined as total equity and total assets less goodwill and other intangibles, net of any deferred tax liabilities.

The Sovereign Bancorp capital ratios at ~~September 30, 2007 have increased from~~ December 31, ~~2006 levels due to significant charges that~~2007 were ~~recorded in the fourth quarter of 2006 related to the balance sheet restructuring and the expense saving initiatives as discussed in our Form 10-K. However, these ratios were negativity~~negatively impacted 220 basis points to 3533 basis points ~~at September 30, 2007~~depending on the ratio due to a balance sheet gross up of ~~$4.5~~$4 billion of investments and cash deposits in order to comply with a loan limitation test required by ~~the Home Owners Loan Act (HOLA).~~HOLA. As discussed in our Form 10-K, HOLA limits the amount of non-residential mortgage loans a savings institution, such as Sovereign Bank, may make. The law limits a savings institution to a maximum of 20% of its total assets in commercial loans not secured by real estate, however, only 10% can be large commercial loans not secured by real estate (defined as loans in excess of $2 million). Commercial loans secured by real estate can be made in an amount up to four times an institutions total risk-based capital. Due to Sovereign’s decreased emphasis of lower yielding asset classes since year-end (primarily investment securities, ~~multifamily~~multi-family loans and residential loans) and increased emphasis on higher yielding commercial loans, Sovereign was required to increase the amount of assets that were not considered large commercial loans in order to comply with the regulation at ~~September~~December 31, 2007. During the second quarter of 2008, Sovereign was able to reduce the amount of large non-real estate commercial loans and maintain compliance with this regulation without temporarily increasing its balance sheet at June 30, ~~2007.~~2008. The Company is working on a more permanent solution to maintain compliance with this regulation in future periods.

As discussed in our Form 10-K, all OTS savings institutions are required to meet a qualified thrift lender (QTL) test to avoid certain restrictions on their operations. The QTL test under HOLA requires a savings institution to have at least 65% of its portfolio assets, as defined by regulation, in qualified thrift investments. Such assets primarily consist of residential housing related loans, certain consumer and small business loans, as defined by the regulations, and mortgage related investments. Sovereign is currently in compliance with the QTL; however, as a result of our 2007 balance sheet restructuring and our recent change in strategy to deemphasize the retention of multi-family and residential mortgage loans to be held on our balance sheet, ongoing compliance with the QTL test in future periods may be challenging. We are currently working with the OTS on a more permanent solution to maintain compliance with this regulation. However, if we are not successful in these efforts, we may need to take certain actions to reduce the amount of commercial loans or increase the amount of qualified thrift investments that are held on our balance sheet. These actions are inconsistent with our current strategy and could adversely impact future earnings and capital levels.

Liquidity and Capital Resources

Liquidity represents the ability of Sovereign to obtain cost effective funding to meet the needs of customers, as well as Sovereign’s financial obligations. Sovereign’s primary sources of liquidity include retail and commercial deposit gathering, ~~Federal Home Loan Bank (FHLB)~~FHLB borrowings, federal funds purchases, reverse repurchase agreements and wholesale deposit purchases. Other sources of liquidity include asset securitizations, loan sales, and periodic cash flows from amortizing mortgage backed securities.

Factors which impact the liquidity position of Sovereign Bank include loan origination volumes, loan prepayment rates, maturity structure of existing loans, core deposit growth levels, CD maturity structure and retention, Sovereign’s credit ratings, general market conditions, investment portfolio cash flows and maturity structure of wholesale funding, etc. These risks are monitored and centrally managed. This process includes reviewing all available wholesale liquidity sources. As of ~~September~~June 30, ~~2007,~~2008, Sovereign had ~~$13.2~~$20.4 billion in available overnight liquidity in the form of unused federal funds purchased lines, unused FHLB borrowing capacity and unencumbered investments to be pledged as collateral for additional borrowings. Sovereign also forecasts future liquidity needs and develops strategies to ensure that adequate liquidity is available at all times.

Sovereign Bancorp has the following major sources of funding to meet its liquidity requirements: dividends and returns of investment from its subsidiaries, a revolving credit agreement and access to the capital markets. Sovereign Bank may pay dividends to its parent subject to approval of the OTS, as discussed above. Sovereign also has approximately ~~$1.8 billion~~$87.5 million of availability under a shelf registration statement on file with the Securities and Exchange Commission permitting access to the public debt and equity markets. During the second quarter of 2008, Sovereign issued $1.39 billion of common stock through its shelf registration.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)

As previously mentioned Sovereign adopted FAS 157 on January 1, 2008. Sovereign’s level 3 investments are comprised of certain non-agency mortgage backed securities, collateralized debt obligations and FNMA/FHLMC preferred stock, which are not actively traded. In certain instances, Sovereign is the sole investor of the issued security. Sovereign receives third party broker quotes to determine their estimated fair value. The prices of our securities are benchmarked against similar securities that are more actively traded to validate the reasonableness of their fair value. Our fair value estimates assume liquidation in an orderly market and not under distressed circumstances. If Sovereign was required to sell these securities in an unorderly fashion, actual proceeds received could potentially be significantly less than their estimated fair values.

Cash and cash equivalents ~~increased $2.2~~decreased $2.0 billion from December 31, ~~2006.~~2007. The reason for the decline is due to a temporary increase in year-end cash deposits to comply with a loan limitation test required by the Home Owners Loan Act (HOLA). HOLA limits the amount of non-residential mortgage loans a savings institution, such as Sovereign Bank, may make. The law limits a savings institution to a maximum of 20% of its total assets in commercial loans not secured by real estate; however, only 10% can be large commercial loans not secured by real estate (defined as loans in excess of $2 million). Commercial loans secured by real estate can be made in an amount up to four times an institutions total risk-based capital. Sovereign was required to increase the amount of assets that were not considered large commercial loans in order to comply with the regulation at December 31, 2007. No such increase was necessary at June 30, 2008. The Company is working on a more permanent solution to maintain compliance with this regulation in future periods.

Net cash provided by operating activities was ~~$485.8~~$750.1 million for ~~2007.~~2008. Net cash provided by investing activities for ~~2007~~2008 was ~~$4.8~~$2.6 billion and consisted primarily of proceeds from the ~~sale~~maturity and repayments of ~~loans~~investments of ~~$9.1~~$3.4 billion, offset by originations in excess of repayments of loans of ~~$3.5 billion.~~$593.4 million. Net cash used by financing activities for ~~2007~~2008 was ~~$3.1~~$5.3 billion, which was primarily due to ~~repayment~~a reduction in wholesale borrowings of ~~debt obligations of $2.3~~$4.4 billion and a decrease in deposits of ~~$2.3 billion~~$2.6 million, offset by $1.4 billion of proceeds from ~~borrowings and other debt obligations~~the issuance of ~~$1.6 billion.~~common stock. See the Consolidated Statement of Cash Flows for further details on our sources and uses of cash.

Sovereign’s debt agreements impose customary limitations on dividends, other payments and transactions. These limits are not expected to affect dividend payments at current levels, or if declared, reasonably anticipated increases.

5251

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~

Sovereign’s senior credit facility requires Sovereign to maintain certain financial ratios and to maintain a “well capitalized” regulatory status. Sovereign has complied with these covenants as of ~~September~~June 30, ~~2007~~2008 and expects to be in compliance with these covenants for the foreseeable future. However, if in the future Sovereign is not in compliance with these ratios or is deemed to be other than well capitalized by the OTS, and is unable to obtain a waiver from its lenders, Sovereign would be in default under this credit facility and the lenders could terminate the facility and accelerate the maturity of any outstanding borrowings thereunder. Due to cross-default provisions in such senior credit facility, if more than $5 million of Sovereign’s debt is in default, Sovereign will be in default under this credit facility and the lenders could terminate the facility and accelerate the maturity of any borrowings thereunder.

Sovereign is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, loans sold with recourse, forward contracts and interest rate swaps, caps and floors. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of these financial instruments reflect the extent of involvement Sovereign has in particular classes of financial instruments. Commitments to extend credit, including standby letters of credit, do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon.

Sovereign’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and loans sold with recourse is represented by the contractual amount of those instruments. Sovereign uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. For interest rate swaps, caps and floors and forward contracts, the contract or notional amounts do not represent exposure to credit loss. Sovereign controls the credit risk of its interest rate swaps, caps and floors and forward contracts through credit approvals, limits and monitoring procedures.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis~~ See Note 14 for a description of ~~Financial Condition and Results of Operations (continued)~~pending litigation against the Company.

Asset and Liability Management

Interest rate risk arises primarily through Sovereign’s traditional business activities of extending loans and accepting deposits. Many factors, including economic and financial conditions, movements in market interest rates and consumer preferences, affect the spread between interest earned on assets and interest paid on liabilities. In managing its interest rate risk, the Company seeks to minimize the variability of net interest income across various likely scenarios while at the same time maximizing its net interest income and net interest margin. To achieve these objectives, the treasury group works closely with each business line in the Company and guides new business. The treasury group also uses various other tools to manage interest rate risk including wholesale funding maturity targeting, investment portfolio purchase strategies, asset securitization/sale, and financial derivatives.

Interest rate risk is managed centrally by the treasury group with oversight by the Asset and Liability Committee. Management reviews various forms of analysis to monitor interest rate risk including net interest income sensitivity, market value sensitivity, repricing frequency of assets versus liabilities and scenario analysis. Numerous assumptions are made to produce these analyses including, but not limited to, assumptions on new business volumes, loan and investment prepayment rates, deposit flows, interest rate curves, economic conditions, and competitor pricing.

Sovereign simulates the impact of changing interest rates on its expected future interest income and interest expense (net interest income sensitivity). This simulation is run monthly and it includes up to twelve different stress scenarios. These scenarios shift interest rates up and down. Certain other scenarios shift short-term rates up while holding longer-term rates constant and vice versa. These shocks are instantaneous and the analysis helps management to better understand its short-term interest rate risk. Actual rate shifts do not occur in an instantaneous manner but these stress scenarios help to better highlight imbalances. This information is then used to develop proactive strategies to ensure that the Company is not overly sensitive to the future direction of interest rates.

The table below discloses the estimated sensitivity to Sovereign’s net interest income based on interest rate changes:


	The following estimated percentage
If interest rates changed in parallel by the	increase/(decrease) to net interest
amounts below at ~~September~~June 30, ~~2007~~2008	income would result

Up 100 basis points		(~~2.49~~0.87	)%
Down 100 basis points		~~2.41~~1.12	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

PART II –— OTHER INFORMATION

Item 1A –— Risk Factors

There has been no material change in the Corporation’s risk factors as previously disclosed in our Form 10-K for the fiscal year ended December 31, ~~2006~~2007 in response to Item 1A to Part I of such Form 10-K. Such risk factors are incorporated herein by reference.

Item 2 –— Unregistered Sales of Equity Securities and Use of Proceeds.

The table below summarizes the Company’s repurchases of common equity securities during the quarter ended ~~September~~June 30, ~~2007:~~2008:

Maximum Number
Average Total Number of of Shares
Total Price Shares Purchased that may be
Number of Paid as Part of Publicly Purchased Under
Shares Per Announced Plans the Plans or
Period Purchased Share or Programs (1) Programs (1)
7/1/07 through 7/31/07 12,686 $ 22.20 N/A 19,500,000
8/1/07 through 8/31/07 11,793 18.07 N/A 19,500,000
9/1/07 through 9/30/07 10,250 16.99 N/A 19,500,000

Total Number of

Maximum Number

Total

Average Price

Shares Purchased

of Shares that

Number of

Paid

as Part of Publicly

may be Purchased

Per

Announced Plans

Under the Plans

Period

Purchased

or Programs (1)

Or Programs (1)

4/1/08 through 4/30/08

25,378

9.57

N/A

19,500,000

5/1/08 through 5/31/08

864

9.19

N/A

19,500,000

6/1/08 through 6/30/08

10,439

8.54

N/A

19,500,000


(1)		Sovereign has three stock repurchase programs in effect that would allow the Company to repurchase up to 40,500,000 shares of common stock as of ~~September~~June 30, ~~2007~~2008 of which approximately twenty one million shares have been purchased under these repurchase programs as of ~~September~~June 30, ~~2007.~~2008. All of Sovereign’s stock repurchase programs have no prescribed time limit in which to fill the authorized repurchase amount. Sovereign does occasionally repurchase its common securities on the open market to fund equity compensation plans for its employees. Additionally, Sovereign repurchases its shares from employees who surrender a portion of their shares received through the Company’s stock based compensation plans to cover their associated minimum income tax liabilities. Sovereign repurchased 36,681 shares outside of publicly announced repurchase programs during the second quarter of 2008.

Item 4 — Submission of Matters to a Vote of Security Holders

The 2008 annual meeting of the shareholders of Sovereign ~~does occasionally repurchase its common securities~~Bancorp, Inc. was held on May 8, 2008. The following is a brief description of each matter voted on at the open market to fund equity compensation plans for its employees. Additionally, Sovereign repurchases its shares from employees who surrender a portion of their shares received through the Company’s stock based compensation plans to cover their associated minimum income tax liabilities. Sovereign repurchased 34,729 shares outside of publicly announced repurchase programs during the third quarter of 2007.meeting.


	SHARES
									BROKER
PROPOSAL	FOR		AGAINST		WITHHELD		ABSTENTIONS		NON-VOTES

1. To elect four (4) Class III directors of Sovereign, each to serve for a term of three years and until their successors shall have been elected and qualified:
Joseph P. Campanelli		361,705,710		N/A		36,137,820		—		—
William J. Moran		363,229,262		N/A		34,614,269		—		—
Maria Fiorini Ramirez		362,913,316		N/A		34,930,214		—		—
Alberto Sanchez		312,536,170		N/A		85,307,360		—		—
2. To ratify the appointment by the Audit Committee of Sovereign’s Board of Directors of Ernst & Young LLP as Sovereign’s independent auditors for the fiscal year ending December 31, 2008		391,807,577		3,265,820		—		2,770,132		—
3. To approve the shareholder proposal to amend the Sovereign Bancorp, Inc. 2004 Broad-Based Stock Incentive Plan		309,495,948		13,318,750		—		3,414,827		71,614,005

5856


Pennsylvania		23-2453088

(State or other jurisdiction of		~~(I.R.S. Employer~~
incorporation or organization)		(I.R.S. Employer Identification No.)


1500 Market Street, Philadelphia, Pennsylvania		~~19102~~
(Address of principal executive offices)		19102 (Zip Code)


Large accelerated filerþ		Accelerated filero		Non-accelerated filero (Do not check if a smaller reporting company)		Smaller Reporting Companyo


Class		Outstanding at ~~October 31, 2007~~
		July 21, 2008
Common Stock (no par value)		~~480,561,629~~662,741,960 shares


	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006~~2007		4
Consolidated Statements of Operations for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007~~2008 and ~~2006~~2007		5-6
Consolidated Statement of Stockholders’ Equity for the ~~nine-month~~six-month period ended ~~September~~June 30, ~~2007~~2008		7
Consolidated Statements of Cash Flows for the ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007~~2008 and ~~2006~~2007		8-9
Notes to Consolidated Financial Statements		~~10–29~~10-29
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		~~30–56~~30-54
Item 3. Quantitative and Qualitative Disclosures About Market Risk		5755
Item 4. Controls and Procedures		5755
PART II. OTHER INFORMATION
Item 1A. Risk Factors		5856
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		5856
Item 6. Exhibits		5957
SIGNATURES		6058
EXHIBITS INDEX		6159
Ex-31.1 Certification
Ex-31.2 Certification
Ex-32.1 Certification
Ex-32.2 Certification
~~Chief Executive Officer certification pursuant to Rule 13a-14(a)~~
~~Chief Financial Officer certification pursuant to Rule 13a-14(a)~~
~~Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350~~
~~Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350~~


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


	•		technological changes;

	•		competitors of Sovereign may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than Sovereign;

	•		changes in consumer spending and savings habits;

	•		acts of terrorism or domestic or foreign military conflicts; and acts of God, including natural disasters;

	•		regulatory or judicial proceedings;

	•		changes in asset quality;

	•		the outcome of ongoing tax audits by federal, state and local income tax authorities may require additional taxes be paid by Sovereign as compared to what has been accrued or paid as of period end; and

	•		Sovereign’s success in managing the risks involved in the foregoing.


(1)		~~These items were~~This item was excluded from diluted earnings per share for the three-month and ~~nine-month~~six-month periods ended ~~September~~June 30, ~~2007~~2008 since the result would have been anti-dilutive.

(2)		Based on Sovereign’s closing stock price on June 30, 2008 of $7.36, Sovereign had 9.8 million of outstanding stock options that were out-of-the-money (exercise price of award exceeded $7.36).

(3)		On May 16th, 2008, Sovereign issued 179.7 million shares of common stock which raised net proceeds of $1.39 billion to enhance its capital and liquidity positions. As a result, this increased our weighted average shares outstanding during the second quarter by 90.8 million. Therefore, our weighted average share count in the third quarter will increase due to the full quarter impact of this transaction by approximately 88.9 million shares.


	September 30, 2007								June 30, 2008
	Amortized		Unrealized		Unrealized		Fair		Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value		Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	2,124,715	$	461	$	13	$	2,125,163	$	66,432	$	130	$	266	$	66,296
Debentures of FHLB, FNMA, and FHLMC		198,194		4,582		60		202,716		19,822		2,509		—		22,331
Corporate debt and asset-backed securities		954,703		8		97,411		857,300		923,322		7		411,919		511,410
Equity securities (1)		819,467		5,217		11,413		813,271		638,614		612		34,469		604,757
State and municipal securities		2,506,999		17,424		30,797		2,493,626		2,502,985		11,713		96,872		2,417,826
Mortgage-backed securities:
U.S. government agencies		256,069		479		1,086		255,462		232,373		1,950		34		234,289
FHLMC and FNMA debt securities		3,711,993		4,611		16,686		3,699,918		4,424,855		25,126		24,586		4,425,395
Non-agency securities		3,925,817		7,614		72,958		3,860,473		3,152,783		605		317,508		2,835,880


Total investment securities available-for-sale	$	14,497,957	$	40,396	$	230,424	$	14,307,929	$	11,961,186	$	42,652	$	885,654	$	11,118,184


(1)		Equity securities consist principally of preferred stock of FHLMC and FNMA.


	At September 30, 2007
	Less than 12 months					12 months or longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
U.S. Treasury and government agency securities	$	—	$	—		$	3,027	$	(13	)	$	3,027	$	(13	)
Debentures of FHLB, FNMA and FHLMC		—		—			57,822		(60	)		57,822		(60	)
Corporate debt and asset-backed securities		532,111		(72,819	)		187,746		(24,592	)		719,857		(97,411	)
Equity securities		375,770		(11,413	)		—		—			375,770		(11,413	)
State and municipal securities		1,759,035		(30,717	)		21,114		(80	)		1,780,149		(30,797	)
Mortgage-backed Securities:
U.S. government agencies		215,587		(1,007	)		2,170		(79	)		217,757		(1,086	)
FHLMC and FNMA debt securities		3,018,839		(13,686	)		107,527		(3,000	)		3,126,366		(16,686	)
Non-agency securities		1,231,445		(18,730	)		1,643,056		(54,228	)		2,874,501		(72,958	)


Total investment securities available-for-sale	$	7,132,787	$	(148,372	)	$	2,022,462	$	(82,052	)	$	9,155,249	$	(230,424	)


	At December 31, 2006
	Less than 12 months					12 months or longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
U.S. Treasury and government agency securities	$	1,495,712	$	(733	)	$	15,995	$	(145	)	$	1,511,707	$	(878	)
Debentures of FHLB, FNMA and FHLMC		—		—			101,341		(1,149	)		101,341		(1,149	)
Corporate debt and asset-backed securities		446,261		(4,014	)		61,820		(2,301	)		508,081		(6,315	)
State and municipal securities		247,409		(1,312	)		21,239		(182	)		268,648		(1,494	)
Mortgage-backed Securities:
U.S. government agencies		219		(8	)		2,258		(97	)		2,477		(105	)
FHLMC and FNMA debt securities		641,851		(1,009	)		126,193		(4,176	)		768,044		(5,185	)
Non-agency securities		456,897		(1,703	)		1,962,694		(50,662	)		2,419,591		(52,365	)


Total investment securities available-for-sale	$	3,288,349	$	(8,779	)	$	2,291,540	$	(58,712	)	$	5,579,889	$	(67,491	)


(1)		Includes residential and commercial construction loans of $2.6 billion and $2.3 billion at June 30, 2008 and December 31, 2007, respectively.

(2)		Total loans held for investment includes deferred loan origination costs, net of deferred loan fees and unamortized purchase premiums, net of discounts as well as purchase accounting adjustments. These items resulted in a net ~~increase~~decrease in loans of ~~$268.3~~$7.6 million and ~~$258.4~~$7.2 million at ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, respectively. Loans pledged as collateral totaled ~~$15.4~~$33.8 billion and ~~$17.7~~$31.3 billion at ~~September~~June 30, ~~2007~~2008 and December 31, ~~2006,~~2007, respectively.


	September 30, 2007								December 31, 2006
						Weighted								Weighted
						Average								Average
Account Type	Amount		Percent			Rate			Amount		Percent			Rate
Demand deposit accounts	$	6,272,412		13	%		—	%	$	6,577,585		12	%		—	%
NOW accounts		5,352,228		11			1.11			6,333,667		12			1.24
Wholesale NOW		4,319,805		9			4.97			3,573,861		7			4.97
Customer repurchase agreements		2,726,686		5			3.95			2,206,445		4			4.74
Savings accounts		3,984,551		8			0.68			4,637,346		9			0.65
Money market accounts		10,258,960		20			3.71			8,875,353		17			3.17
Wholesale money market accounts		1,556,973		3			5.00			4,116,417		8			5.51
Certificates of deposit		11,970,145		24			4.63			11,338,935		22			4.45
Wholesale certificates of deposit		3,656,288		7			5.19			4,724,945		9			5.14


Total deposits	$	50,098,048		100	%		3.21	%	$	52,384,554		100	%		3.14	%


	Notional						Receive			Pay			Life		Notional						Receive			Pay			Life
	Amount		Asset		Liability		Rate			Rate			(Years)		Amount		Asset		Liability		Rate			Rate			(Years)
September 30, 2007
June 30, 2008
Fair value hedges:
Receive fixed – pay variable interest rate swaps	$	1,091,000	$	—	$	10,485		4.31	%		5.33	%		3.2
Receive fixed — pay variable interest rate swaps															$	204,000	$	708	$	506		4.26	%		2.57	%		1.2
Cash flow hedges:
Pay fixed – receive floating interest rate swaps		7,900,000		1,443		93,845		5.22	%		4.95	%		2.7
Pay fixed — receive floating interest rate swaps																7,950,000		—		213,541		2.76	%		5.15	%		1.8


Total derivatives used in SFAS 133 hedging relationships	$	8,991,000	$	1,443	$	104,330		5.11	%		5.00	%		2.7	$	8,154,000	$	708	$	214,047		2.80	%		5.09	%		1.8


December 31, 2006
December 31, 2007
Fair value hedges:
Receive fixed – pay variable interest rate swaps	$	1,344,000	$	—	$	22,806		4.16	%		5.25	%		1.8
Receive fixed — pay variable interest rate swaps															$	925,000	$	413	$	2,220		4.29	%		4.87	%		0.9
Cash flow hedges:
Pay fixed – receive floating interest rate swaps		8,500,000		19,174		45,842		5.37	%		5.09	%		2.4
Pay fixed — receive floating interest rate swaps																8,100,000		—		214,548		5.02	%		5.15	%		2.2


Total derivatives used in SFAS 133 hedging relationships	$	9,844,000	$	19,174	$	68,648		5.20	%		5.11	%		2.3	$	9,025,000	$	413	$	216,768		4.94	%		5.12	%		2.1


Gross balance as of December 31, 2006	$	118,638
Mortgage servicing assets recognized		42,227
Amortization		(27,250	)
Write-off of servicing assets		(65	)

Gross balance at September 30, 2007		133,550
Valuation allowance		(501	)

Balance as September 30, 2007	$	133,049


Balance as of December 31, 2006	$	1,222
Write-offs of reserves		(65	)
Decrease in valuation allowance for mortgage servicing rights		(656	)

Balance as September 30, 2007	$	501


			New		Metro New
	Mid-Atlantic		England		York		Shared			Shared								Retail		Corporate
For the three-month period ended	Banking		Banking		Banking		Services			Services								Banking		Specialty			Commercial
September 30, 2007	Division		Division		Division		Consumer			Commercial			Other			Total

June 30, 2008																		Division		Group			Lending			Other			Total
Net interest income (expense)	$	77,848		160,098		138,554		72,452		$	66,655		$	(58,846	)	$	456,761	$	264,891	$	106,304		$	128,818		$	6,117		$	506,130
Fees and other income		20,843		42,271		22,539		12,355			15,626			27,755			141,389
Fees and other income⁽¹⁾																			101,441		52,240			30,614			20,914			205,209
Provision for credit losses		8,864		10,854		14,081		108,728			19,973			—			162,500		13,745		69,693			48,562			—			132,000
General and administrative expenses		69,486		118,347		110,290		30,319			36,696			(23,492	)		341,646		266,616		44,241			56,347			14,659			381,863
Depreciation/Amortization		2,533		3,742		9,244		8,478			2,145			41,294			67,436
Depreciation/amortization																			10,754		12,176			696			37,052			60,678
Income (loss) before income taxes		20,342		73,167		36,721		(50,273	)		25,526			(53,603	)		51,880		85,971		39,942			55,061			(24,415	)		156,559
Intersegment revenues (expense)⁽¹⁾		47,127		173,015		80,396		(265,173	)		(152,979	)		117,614			—
Intersegment revenues (expense)⁽²⁾																			377,213		(323,675	)		(182,117	)		128,579			—
Total average assets	$	5,098,952	$	6,638,444	$	11,078,636	$	23,009,095		$	13,149,289		$	22,622,752		$	81,597,168	$	6,815,730	$	30,196,374		$	22,494,819		$	20,294,827		$	79,801,750


(1)		Included in fees and other income for the three-month period ended June 30, 2008, in the Corporate Specialty Group segment is a $19.8 million residential mortgage servicing right recovery. The majority of this recovery related to the $18.7 million impairment charge that was recorded in the first quarter of 2008. Fees and other income in the Corporate Specialty Group for the six-month period ended June 30, 2007 included a charge of $119.9 million on our correspondent home equity loan portfolio.

(2)		Intersegment revenues (expense) represent charges or credits for funds used or provided by each of the segments and are included in net interest income.


~~(1)~~		~~Includes charge of $382.5 million related to correspondent home equity loans classified as held for sale at December 31, 2006.~~


Related party loans at December 31, 2006	$	59,777
Loan fundings		9,109
Resignation of executive officers		( 1,250	)
Reduction of Sovereign Bank directors		(52,078	)
Loan repayments		( 1,775	)

Related party loan balance at September 30, 2007	$	13,783


Related party loans at December 31, 2007	$	13,963
Loan fundings		4,785
Loan repayments		(672	)
Reduction of executive officers		(1,637	)


Related party loan balance at June 30, 2008	$	16,439


	Contract
	termination			Severance			Other			Total
Accrued at December 31, 2006	$	7,043		$	45,930		$	5,906		$	58,879
Payments		(7,183	)		(48,829	)		(8,908	)		(64,920	)
Charges recorded in earnings		16,007			13,668			6,093			35,768

Accrued at September 30, 2007	$	15,867		$	10,769		$	3,091		$	29,727


Assets
Investments	$	3,126.5
Loans:
Multifamily		5,571.2
Commercial		5,313.3
Consumer		517.2
Residential		1,829.0


Total loans		13,230.7
Less allowance for loan losses		(97.8	)


Total loans, net		13,132.9

Cash acquired, net of cash paid		(2,713.2	)
Premises and equipment, net		167.9
Bank Owned Life Insurance		343.3
Other assets		370.5
Core deposit and other intangibles		394.2
Goodwill		2,280.6


Total assets	$	17,102.7


Liabilities
Deposits:
Core	$	6,960.8
Time		4,070.1


Total deposits		11,030.9
Borrowings and other debt obligations		5,488.8
Other liabilities (1)		583.0


Total liabilities	$	17,102.7


Reserve balance at December 31, 2006	$	22,432
Charge recorded in earnings		2,242
Payments		(18,676	)

Reserve balance at September 30, 2007	$	5,998


(1)		Represents the difference between the yield on total earning assets and the cost of total funding liabilities.

(2)		Represents annualized, taxable equivalent net interest income divided by average interest-earning assets.


(1)		Sovereign defines the provision for credit losses on the consolidated statement of operations as the sum of the total provision for loan losses and provision for unfunded lending commitments.


	Three months ended						Nine months ended
	September 30,						September 30,
	2007			2006			2007			2006
Mortgage servicing fees	$	10,504		$	8,923		$	30,693		$	21,641
Amortization of mortgage servicing rights		(9,532	)		(5,165	)		(27,250	)		(13,868	)
Net gains/(loss) under SFAS 133		1,781			(423	)		2,176			4
Recoveries of/(Impairments to) mortgage servicing rights		—			(3,671	)		656			(3,495	)
Net gain/(loss) recorded on commercial mortgage backed securitization		(5,355	)		—			5,141			—
Sales of mortgage loans and related securities, home equity and multifamily loans		6,354			14,665			(88,369	)		27,563

Total mortgage banking income	$	3,752		$	14,329		$	(76,953	)	$	31,845


(1)		Allowance for credit losses is comprised of the allowance for loan losses and the reserve for unfunded commitments, which is included in other liabilities.

~~(2)~~		Non-performing loans and non-performing assets at September 30, 2007 include $41.5 million of loans related to our correspondent home equity loan portfolio. Non-performing loans and non-performing assets at December 31, 2006 exclude $21.5 million of residential non-accrual loans and $66.0 million of home equity non-accrual loans that are classified as held for sale.

~~(3)~~		Includes lower of cost of market adjustments resulting in a charge-off of $382.5 million on the correspondent home equity loans and a charge-off of approximately $7.1 million on the purchased residential mortgage portfolio both of which were classified as held for sale at December 31, 2006. These charge-offs accounted for 71 basis points of the total 96 basis points above.

~~(4)~~		~~The calculation of these ratios at December 31, 2006 excludes $7.6 billion of loans held for sale.~~


(1)		Minimum capital requirement as defined by OTS Regulations.


	Payments Due by Period										Payments Due by Period
			Less than		Over 1 yr		Over 3 yrs		Over				Less than		Over 1 yr		Over 3 yrs		Over
	Total		1 year		to 3 yrs		to 5 yrs		5 yrs		Total		1 year		to 3 yrs		to 5 yrs		5 yrs
FHLB advances (1)	$	23,096,033	$	15,767,237	$	1,144,321	$	1,387,274	$	4,797,201	$	18,679,037	$	10,274,808	$	2,810,496	$	1,323,292	$	4,270,441
Securities sold under repurchase agreements (1)		79,679		79,679		—		—		—		77,264		77,264		—		—		—
Fed Funds (1)		1,390,081		1,390,081		—		—		—		1,202,067		1,202,067		—		—		—
Other debt obligations (1)		2,881,899		287,051		1,238,160		106,750		1,249,938		3,561,554		339,623		1,092,994		844,250		1,284,687
Junior subordinated debentures due to Capital Trust entities (1)(2)		4,101,966		91,399		180,594		183,056		3,646,917		3,998,467		87,314		178,361		181,911		3,550,881
Certificates of deposit (1)		16,180,050		14,504,521		1,340,042		271,172		64,315		12,010,961		10,447,452		1,256,491		229,038		77,980
Investment partnership commitments (3)		36,692		24,402		12,162		32		96		21,295		14,557		6,627		26		85
Operating leases		821,161		99,093		173,200		154,796		394,072		782,078		97,037		175,882		143,510		365,649


Total contractual cash obligations	$	48,587,561	$	32,243,463	$	4,088,479	$	2,103,080	$	10,152,539	$	40,332,723	$	22,540,122	$	5,520,851	$	2,722,027	$	9,549,723


(1)		Includes interest on both fixed and variable rate obligations. The interest associated with variable rate obligations is based upon interest rates in effect at ~~September~~June 30, ~~2007.~~2008. The contractual amounts to be paid on variable rate obligations are affected by changes in market interest rates. Future changes in market interest rates could materially affect the contractual amounts to be paid.

(2)		Excludes unamortized premiums or discounts.

(3)		The commitments to fund investment partnerships represent future cash outlays for the construction and development of properties for low-income housing, and historic tax credit projects. The timing and amounts of these commitments are projected based upon the financing arrangements provided in each project’s partnership or operating agreement, and could change due to variances in the construction schedule, project revisions, or the cancellation of the project.


	Total										Total
Other Commercial	Amounts		Less than		Over 1 yr		Over 3 yrs				Amounts		Less than		Over 1 yr		Over 3 yrs
Commitments	Committed		1 year		to 3 yrs		to 5 yrs		Over 5 yrs		Committed		1 year		to 3 yrs		to 5 yrs		Over 5 yrs
(in thousands of dollars)

Commitments to extend credit	$	21,315,522	$	10,373,379	$	3,335,154	$	3,203,758	$	4,403,231	$	19,772,570	$	8,240,534	$	4,060,896	$	2,351,923	$	5,119,217
Standby letters of credit		2,632,131		508,825		619,478		1,178,321		325,507		3,057,532		572,441		846,540		1,145,749		492,802
Loans sold with recourse		258,125		5,106		25,769		44,800		182,450		296,569		6,382		31,593		68,677		189,917
Forward buy commitments		851,170		763,224		87,946		—		—		767,840		635,772		132,068		—		—



Total commercial commitments	$	25,056,948	$	11,650,534	$	4,068,347	$	4,426,879	$	4,911,188	$	23,894,511	$	9,455,129	$	5,071,097	$	3,566,349	$	5,801,936